As was widely expected, annual inflation increased again last month; there is, however, a big question over how accurately these figures capture the extent of the price increases in different households.
Matthew Whittaker is a senior economist at the Resolution Foundation
As was widely expected, annual inflation increased again last month. A combination of the VAT rise and higher oil prices helped push CPI from 3.7% in December to 4% in January – twice the government’s official target of 2 per cent. The wider RPI measure also increased, from 4.8% to 5.1%.
There is, however, a big question over how accurately these figures capture the extent of the price increases in different households.
As reported by Larry Elliot and Simon Briscoe, some statisticians are concerned that official measures of inflation understate real trends in the cost of living being faced by consumers.
The problem goes beyond the government’s decision to shift benefit-indexing from the RPI to the lower CPI measure. It raises wider questions about how and why we’ve settled on these particular definitions of inflation in the first place. Our analysis at the Resolution Foundation shows that headline inflation figures fail to capture differences in spending habits – and therefore price increases – across different household types.
In recent years, rapid increases in the costs of staple goods such as food and fuel mean that the difference between the inflation faced by those in the upper half of the income distribution (higher earners) and those living in low-to-middle income households has grown. This reflects the fact that food and fuel account for a larger share of expenditure in lower income households, so when prices in these commodities rise, these households are hit particularly hard.
The chart below captures the cumulative impact of these varying spending habits on the purchasing power of different households over time:
From 2000-2006, the impact was fairly trivial: sometimes inflation was higher for low-to-middle earners, and sometimes it was lower – the cumulative impact on their spending power over time was negligible.
But since 2006, a solid gap has opened up in the impact of inflation on low-to-middle earners versus higher earners. Today, if low-to-middle earners had faced the same level of inflation as higher earners in the period since 2000, their typical annual basket of goods would cost about £155 less than it currently does. This is lower than the peak difference of around £300 reached in 2009, but it is still much bigger than the variation in inflation’s impact we saw in the first half of the last decade.
This all matters because government income-support mechanisms like tax credits are indexed to headline levels of inflation. As a result annual increases in payments are unlikely to have kept pace with real rises in the cost of living being experienced in low-to-middle earner households in recent years. The shift to the lower CPI measure from April will only make this situation worse.
And of course, the resultant squeeze on low-to-middle earner’s living standards is compounded by the fact real wages have been falling in the past year – average annual earnings growth stood at just 2.4% in November – and are expected to continue to decline until 2013.
For all the anxiety about headline inflation figures that will be voiced in tomorrow’s papers, the reality is likely to be worse for those on low and middle incomes.
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13 Responses to “Time to think again about the way we measure inflation?”
Red Rag
Last months excuse was snow, this months excuse is world prices…..wonder what next months excuse will be?
http://redrag1.blogspot.com/2011/02/red-rag-holes-in-osbornes-plans-are.html
scandalousbill
Mike Thomas,
You Blather on,
“This inflation is hurting people on lower incomes because this inflation is concentrated on raw materials and foods.
Why?
Because some bright spark debased the currency by injecting 20% GDP through QE into the economy to prop up government spending.”
So, the Global recession and the bailing out of the banks, let alone that QE was in the mainstream the purchase of Toxic assets predicated by the former, had absolutely nothing whatsoever with the problem. Right? It was just Brown and Darling on some super shopping spending spree? How deep an observation, how astute!
I take back my former suggestions that you read more. The only question I have based upon your comments on this and other postings is this, can you read these articles without moving your lips?
Mike Thomas
@scandalousbill.
QE was the purchase of government bonds by banks in exchange for electronically created money. The Bank of England then lent that money to the banks. In other words, the Bank of England created funny money, bought government debt as collateral and sold that to the banks.
In other words, the government socialised its debts and its failing into the banks as a means to provide ‘liquidity’.
It was not and was never a purchase of toxic bank debts, 99% of QE was used to buy government debt. Not one single bank was made by the government to open its books, not even Northern Rock.
Get your facts right first.
The main inflator in the economy is a 9% GDP inflator because of a 25% depreciation of the pound as a result of QE. There was never, ever, any threat of deflation with that kind of depreciation. Deflation was the political cover story for increasing the money supply by 20% GDP.
Lastly @redrag. Look at the international price of oil, gold, copper, wheat, cotton – they have all gone through the roof as commodities due to economies around the world recovering and we have a double whammy because Laurel and Hardy debased Sterling by ‘printing’ money.
Currently raw material prices are up 15% in a year and factory gate prices are up 5% on the back of a flat to falling currency.
There’s the source of our extra inflation, it is imported or in your fantasy world can we do without food, oil and raw materials?
scandalousbill
Mike Thomas,
When you drop the venom and cat calls you can make intelligent comment.
You say with regard to QE:
“It was not and was never a purchase of toxic bank debts, 99% of QE was used to buy government debt.”
I think we are talking first hand vs. second hand acquisition in this case. In other words, I cannot see how massive equity purchases of seriously devalued assets, whose value further deteriorated and whose deteriorated state still persists after initial purchase, cannot be considered toxic. In combination with lines or credit extended and depositor guarantees, the impacts of global factors, such as hedge fund activity in the energy sector and considerable equity shorting to me were triggers of currency pressure.
Simply you take the supply side notion of QE as trigger; I see it more as an attempted mediation effort. For your position to hold true, it seems to me that the case should be made that currency devaluation would not have occurred otherwise. I think you will agree that most economists have assessed the recession as globally induced as opposed to country specific factors.
Would the change of policy advocated by the Tory opposition have provided an effective alternative? If you view their position in a historical context, the situation of the 1930’s depression would suggest not. Some would say that it would have made things worse.
Kyle Grayson
Measures of inflation in the UK need to be disaggregated based on income: http://bit.ly/f8tYVu