How government uses inflation to drive up costs

Politicians and political commentators are eager to focus on the consequences of tax changes - or constitution altering deals - on a household's income, not averse to seizing the initiative in debate on sums on the order of a few hundred pounds per year. And they should be. These few hundreds can be very important in personal budgeting, and in significantly improving or diminishing the standard of living for those most vulnerable in society. It's also a convenient vehicle for outlining key ideological differences between parties and describing to the electorate the party's vision for the distribution of responsibilities among society and the role the state should take.

This seemingly stands in great contrast to matters like measuring inflation, which one might assume is devoid of areas of debate. Distinctions between RPI, CPI, and CPIh are not matters of great public concern, because it seems unreasonable to suggest that these distinctions are being exploited for political gain. The calculation of the value of money relative to goods bears no impression on ideology, and hence plays no part in the debate of competing visions of society. It is a matter for economists to determine and provide for policymakers to make informed decisions, and, as such, commands very little of the public debate.

But we should be talking about RPI. All measures of inflation are made by taking a ‘representative’ basket of goods and tracking the increase in the cost of that basket over time. The distinction between different measures of inflation are the choices of the basket, and the way in which the averages are calculated. The two main measures considered within the UK are CPI (consumer price index) and RPI (retail price index), with a modern third index called CPIh, in which the ‘h’ stands for housing, which is intended to be phased in over time. In terms of data collection, CPI and RPI differ in that the population used for CPI is significantly larger, and the basket of goods for RPI includes costs such as mortgage payments and council tax, whereas CPI doesn’t (though CPIh does), and hence is heavily affected by interest rate changes. Mathematically, CPI uses geometric means (a mean based on the product of the goods involved, and considered a better indicator of what’s happening to more people than other means) whereas RPI uses the arithmetic mean (the standard average people are taught in schools).

None of this is particularly important for the average voter; what is important is that RPI for various reasons is not considered to meet international standards, is not considered fit for use by the monetary policy committee of the Bank of England, and is considered fundamentally flawed by the UK’s Office for National Statistics.

The reason we need to be talking about this is because the value of your income and your savings is being artificially diminished by political decisions and pressures. This measure of inflation is ubiquitous and policies directly linked to it touch on most people's finances in a noticeable way. The unjustified increases in train fares is a consequence of linking fare increases to RPI (itself a political decision, but one that should be discussed separately); interest on student loans is RPI+3% for English and Welsh students who started their degree after 2012 and RPI for others; much government debt is index-linked to RPI, so that the value the government owes to the debtor increases with RPI, which is debt ultimately paid off by tomorrow’s taxpayer.

To varying extents, this is fine: an argument can be made that if the government is to limit rail fares, it is unreasonable to expect companies to stick around in an environment where their income is outstripped by inflation; an argument can be made that students who benefit from their education should contribute towards repaying the cost, contingent on their financial success; and an argument can be made that the government is able to generate a higher demand for government debt by ensuring the continued value of its debt, making borrowing easier.

These arguments could all be legitimately had, were it not for the fact that RPI is not fit for purpose. The Office for National Statistics has repeatedly and publicly stated that the figure should not be used for policy purposes, and produces it only for legacy purposes. It has described it as fundamentally unsalvageable, claiming that the index "does not have the potential to become a good measure of inflation." What's significant about this is that the error in RPI is seen to consistently overestimate inflation.

Compared to CPI, we see that RPI has been roughly 2% higher for nearly the last decade. This ratchets up to a significant error; in October this year, the Lords’ economic affairs committee was told by a deputy governor of the Bank of England that known flaws in the measure have cost the taxpayer "tens of billions of pounds." This is a combination of the compounding effect of the error, and the sheer scale of dependence on RPI; the index-linked government bond market - that taxpayers ultimately pay for - is worth £400 billion. This doesn't factor in the cost of the error due to increased costs of daily commutes, or the over-payment of student debt which, according to Labour research, is up to £16,000.

Despite the bland nature of the topic, it is, like most things, ultimately political. The Government has in some areas rejected RPI. In 2011 the Government made the decision to link public sector pensions to CPI rather than RPI. This is presumably because it is more politically convenient to use this sleight of hand to pay public sector employees less in retirement than it is for a Conservative government to consider offending the older vote by touching the triple lock, similarly connected to RPI, or by affecting investor appetite by uprating bonds by values that genuinely reflect the value of money.

If we're willing to debate over the sums of money involved in changes to tax schemes, we should be willing to debate the effect of this flawed measure on our lives. We should hold accountable the Government that is asking us to pay more by exploiting a discredited measure. We should be mad that Phillip Hammond refuses to show leadership on this issue, blaming a lack of initiative on part of the ONS, who he claimed could "find its way to my office relatively easily," to a Lords committee convened on this matter. In fact, five years prior the previous Statistics Authority chief executive claimed that the measure did not meet international standards, and that a new measure should be produced (and in fact has, in the form of CPIh), and the current chair of the UK Statistics Authority has claimed that he would scrap RPI indexed gilts if he had the prerogative to do so. We should be asking if this is to prevent angering a portion of the electorate the Conservative party can rely on; and Labour should be providing alternatives to ensure that everybody’s pensions remain well protected without simply relying on an overestimation of inflation.

We should be angry that we're being cheated out of our money by Government decisions and Government lethargy, and we should be angry that despite the costs the public bear as a result of this measure the Chancellor is able to be quite so flippant in addressing the House of Lords on this matter. You're losing money that you shouldn't be, and we should be debating this.