As part of its open inquiry into the use of the retail price index (RPI) in assessing government debt repayments and indirect taxes, the economic affairs committee quizzed Chancellor Philip Hammond during a meeting
The committee has been examining RPI and the nature of its use by the government.RPI is used to assess consumer inflation rates and is used by the government to determine debt repayment on government bonds (gilts), business rates, student loan repayments, and other indirect taxes. It is contrasted with the consumer price index including owner occupiers’ housing costs (CPIH). In introducing the subject, Lord Turnbull said that this was motivated by ‘two sources of pressure: as an inadequate measure of inflation, and the other, the sense of index shopping. When the government is paying out money, it indexes on CPIH, which is lower, but when it is coming the other way, like student loans or rail fairs, it uses RPI.’
Hammond noted that the Office of National Statistics (ONS) had final control of RPI. He said that ‘The shortcomings of RPI are well-known and acknowledged. The ONS is independent. It consulted in 2012 and it decided against changing the formula in RPI. It is not for me to change the RPI formula, it is for the ONS to do so’.
He argued against the claim that the government was guilty of ‘index shopping’, commenting that business rates were now based on CPI and additional support was being made available to business rate payers.
According to the Chancellor, any review of RPI would be postponed until austerity measures could be sufficiently relaxed: ‘The government has said that once fiscal consolidation is completed it will review the use of RPI for indirect taxes. We recognise the weaknesses of RPI but of course there is a very significant fiscal impact to moving indirect tax and indexation to another index.
‘There is also the question of what index to used. CPIH has only recently become a national statistic again. The government believes that it should allow time for CPIH to bed in and become accepted by the public and other users.
‘The final point is, whether we like it or not, there is a substantial appetite for RPI-linked debt because our biggest buyers of gilts are very often people with RPI-linked obligations. We have to think carefully about the balance between issuing debt, the interest payments to which could become onerous to the government under certain circumstances, and the need to issue debt into a market where there is buoyant demand which ensures we get attractive pricing.’
Hammond also said that the Debt Management Office (DMO) had been directed to ‘slightly ease up on the trends towards more RPI-linked debt’.
The committee said that it was believed that the government considered RPI to be ‘the best possible index’ that it could realistically achieve. Hammond said that the responsibility for pushing the issue rested with the ONS: ‘It has not approached me and I don’t believe it has approached my predecessors to seek their approval or endorsement for a plan to change RPI. The power to change the way that RPI is computed sits with the ONS.
‘If it decided to make a change that would be detrimental to existing gilt holders, there is a protection clause which would require the Chancellor to approve the change the change because the government has an obligation to redeem index-linked gilts issued before 2005 at par…There would have to be a discussion but it for the ONS to initiate and they have not initiated it with me.’
The committee urged the Chancellor to adopt and open-minded attitude towards a review of the index. It noted that despite low levels of satisfaction, the government had yet to develop a concrete plan for changing it.
The reform of RPI has been a significant political issue in recent years. In March 2018 the ONS issued a report in which it stated that: ‘In recent years, the RPI inflation rate has been around one percentage point higher than the CPIH rate, although the difference between the two measures has varied considerably.’
RPI uses the Carli and Dutot formulae, whereas CPIH use the Jevons formula in place of the Carli. The Carli formula, which has been shown in certain circumstances to introduce an upward bias based on previous in-year indices called 'chain drift', mean that price inflation calculated using it cannot be lower than inflation using the Jevons on the same basket of goods and services. In the recent past, this has on average added 0.7% to the annual RPI measure of inflation compared with the CPIH.
In July 2018 John Pullinger, the UK national statistician and chief executive of the UK statistics authority, gave evidence to the committee on the failings of RPI, including ‘the impact of the index formulae, which create an upward bias; and the impact of the way in which housing costs are treated, particularly thinking about the housing index being proxied by a combination of the house price index and mortgage interest payments, which has a series of problems from a price index point of view because of the way in which the cost of land is baked into that. There is a series of smaller issues with the RPI that I would wish to correct, but particularly the fact that we are missing the top 4% of the income distribution, and pensioner households that are primarily dependent on the state.’
The committee is due to publish a report its findings in autumn 2018.
Report by James Bunney