Calculating price indexes that are theoretically sound, robust, comprehensive, easy to understand, and which reflect underlying reality is one of the hardest tasks in economics. Most measures of domestic inflation have flaws, but perhaps the least fit for purpose is the Retail Price Index (RPI) used in Britain. In official use since 1956 the RPI is calculated in a different way from the alternative Consumer Price Index (CPI) in use since 1996. RPI estimates of underlying inflation are generally at variance from CPI calculations, with the RPI recording annual prices increase at a rate around 0.9 percent higher than the CPI. Estimates for price changes also vary widely by goods category, especially for clothing.
Britain’s National Statistician, John Pullinger, does not rate the RPI, and his negative views have been quoted in the Financial Times. “The RPI is not a good measure of inflation and does not realistically have the potential to become one. “ The RPI is not only inaccurate as a measure of price inflation, but imposes costs on different segments of society.
These differential effects arise from flaws in the mathematical formula used to calculate the RPI and from its use for some purposes while the CPI is used for others. For example, the holders of index-linked bonds worth There are gainers and losers which are both inefficient and unjust since the relative impact makes the distribution of income more unequal. For example, the holders of index-linked bonds worth £407 billion of government debt tied to the RPI, positive discrepancies between the RPI and the CPI mean that bond holders receive compensation for falls in the real value of their stock of assets greater than the cost of purchasing goods as measured by changes in the CPI. In contrast, the holders of the stock of student debt valued at around £60 billion pay more in interest adjusted charges to compensate lenders than if the CPI was used instead. In effect, taxpayers and students are subsidising bond holders as a result of the government’s use of a broken price index. In a similar iniquitous discrepancy rail prices are regulated with respect to the RPI meaning that commuters and travellers are subsidising the shareholders of rail franchise holders.
In the cause of data accuracy what are the options? Some of the discrepancies between the CPI and the RPI can be reduced by changing the method of the latter’s calculation. It is estimated that this would save the British government around £6 billion a year in debt service costs by 2020 and although there would be complaints from pension funds and other holders of index- linked debt no legal challengers are possible.
The vast majority, 94 percent, of index linked debt holders have contracts obliging them to accept an index however calculated or any official index at all. Since the CPI is also “an officially recognised Index measuring changes in the level of UK retail prices” index linked prospectuses would also permit the complete substitution of the CPI for the RPI which would save the government more money. At a stroke by scrapping the RPI the UK Government could reduce its deficit and give relief.