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maxwhkalis

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  1. The first paragraph is all you need to understand. Reflect and come read the rest later. The Office for National Statistics (ONS) has released the Consumer Trends report for the first quarter of 2005, stating that according to our preferred measure inflation the ‘main upward pressure is from fruit, particularly grapes and to a lesser extent, strawberries’. By tracing the methodology behind measuring rates of inflation and how this has changed it is possible to see how the ONS can make such a statement. Inflation has historically been measured by the Retail Price Index (RPI) and RPI excluding mortgage interest payments (RPIX). However, measurement of the UK rate of inflation has been officially replaced by the Consumer Price Index (CPI) in 2003 after emerging in 1997 as the Harmonised Index of Consumer Prices (HICP). RPI is designed to measure ‘inflation, or the cost of living’, (Dictionary of Economics, Penguin, 2003) and is based directly on household expenditure. The dictionary poetically fails to acknowledge the CPI, a measure based on national accounts that aspires to being a ‘better macroeconomic indicator of inflation’ against four criteria assessing the merits of alternative inflation measures: 1) The conceptual basis adopted to record prices. 2) Scope of index. In particular how transactions covered by index correspond to those the monetary policy is intended to influence. 3) Index should be unbiased in relation to what it is trying to measure. May include quality changes or change in formulae for aggregation. 4) Usability: timely, accurate, subject to minimal revisions. As the insufferable jargon suggests, the criteria by which the CPI is favoured is a Euro- preference, designed by Eurostat to help compare inflation levels across the EU. It has merit as an international comparison but why would Gordon Brown possibly choose to adopt this as a national measure? Perhaps because the CPI has been design as stated in criteria 2, to manipulate figures and because it is lower. The CPI has allowed the inflationary pressure from the housing boom to be swept under the carpet in order to keep borrowing cheap and expenditure flowing. By adopting the European perspective as our own national figure Gordon Brown is also leading us towards the arms of he European Central Bank, where our interest rates would be dictated if we joined the Euro. It seems that our national rate of inflation has been dislocated from our British consumer spending identity so it’s no longer a measure of the cost of living and resilience of pounds but an accounting convenience and sleight of hand. The ONS provides RPI and CPI figures, both with and without all housing costs. Summary 1 reveals the impact of the indices and how influential the housing costs are for their results. Summary 1. Housing Impact as % of All Inflation Index Type = 1. With Full Housing 2. Without Housing 3. % Inflation from Housing RPI Measurement Year/1/2/3 1997 3.1 / 2.4 / 23% 2004 3.0 / 1.2 / 60% CPI Measurement Year/1/2/3 1997 1.8 / 1.8 / 0% 2004 1.3 / 1.1 / 15% So where have the differences come from? Firstly, the inclusion of Mortgage Interest Payments (MIP) in RPI is a significant factor. Between 1999 and 2004 the total value of mortgages rose from £6bn to £10bn and re-mortgages rose from £2bn to £8bn. This vast equity release has apparently not manifested considerable inflationary pressure on general prices under CPI as it excludes this expenditure. The RPI has its own problem. It suffers the perverse effect that interest rate raises immediately raise the index even though the increase in interest rates is the principal tool used to lower inflationary pressure. For this reason the RPIX is often preferable. The RPIX is used to address the level of state benefit and pensions. If these matters were based on CPI the issue would surely come under greater scrutiny. A measure has been made to assess the difference between CPI and RPIX (differences summarised in Summary 2). Between 1996 and 2004 inflation has averaged 0.7% p.a. higher according to RPIX. The Office of National Statistics (ONS) proposes it is now 1%. This is half from the formula effect, a purely mathematical difference from measuring geometric averages for CPI (RPIX uses arithmetical average). The other half percent is from the CPI omission of council tax and relating to owner occupied houses; mortgage interest payments (MIP), depreciation, building insurance, ground rent and other house purchase costs. In the CPI overview household fuel and water figures in CPI are heaped in with rent. In this bracket expenditure between 1996-2004 rose 53% but the category’s weighting slumped 23%. This devaluation affects almost a fifth of total household expenditure. Though rentals have increase between 1996-2004 both nominally and as a percentage of the total consumer expenditure, the weighting importance has been reduced. The weight attributed to rent has been devalued by 12% from between 1996 and 2004 when during the same period the expenditure on rent rose 44%. As a percentage of overall domestic spending it grew from 12.4% to 13.7%. The CPI does include a more detailed measure of both actual and imputed rent. The imputed rent values that attempt to factor in the cost of owner occupied dwellings are based on mortgage figures for the last 23 years and assumes both that mortgages make up on average 55% of purchase and that 75% of the value is mortgage repayments. In 2004 average mortgage as percentage of house price was in fact 61% and lenders working with low base rates are pushing this higher. They estimate lenders rates as 5% but this appears undervalued. These genial figures set the average imputed rent cost per household at £15/week. There is acknowledgement that the issue of housing weighting in the CPI ought to be addressed and an advisory committee report is due in January 2006. The last meeting was 1992-94. Perhaps they might suggest a return to establishing the cost of living or basing weights on actual expenditure? It is all pressure on the same money supply and the heaviest increases in expenditure are the most discounted under CPI. If direct expenditure was applied to the current CPI figures the weighting for housing would be 187 rather than 103 and for all rentals it would be not be 48 but 137 not, 99 of which relates to imputed rent. How about using arithmetical averages for doing the arithmetic too? The ONS are not concerned by the diluted measures. The national statistician in November 2004 explained the CPI and RPI weighting changes to parliament, saying that ‘expenditure weights are updated annually so that the indices are representative of consumer spending patterns over time’, though this does not appear to be the case. The ONS compute the statistics, principally for the use of the Monetary Policy Committee. As the prime concern of this Bank of England committee is to provide stability it is not in their interests to rock the boat. Defendants would say that no measure is right or wrong but that they are arbitrary. This word has 4 definitions; 1) Dependent on will or pleasure. 2) Dependent on the decision of a legally recognised authority. 3) Based on mere opinion or preference as opposed to the real nature of things; capricious; unpredictable; inconsistent. 4) Unrestrained in the exercise of will or authority; despotic; tyrannical. Which interpretation of arbitrary does the Treasury’s defendants assume? A low, steady inflation rate has been of little interest to the public. We just expect prices to creep up because it’s what they’ve always done as far as we remember. By keeping the nominal rate artificially low the internal changes have flown below the radar of public perception. The public have been put to sleep by the tangle of terminology of inflationary indicators and nobody argues with the anaesthetist. For example, few people would realise that while house prices are 149% higher than their peak in the eighties, this equates to only a 52% rise in real terms (Office of Deputy PM). People have lost sight of the figures and are riding a feel good factor that is not supported by real figures. Though the fruit salad looked like a healthy option we are still the brats eating our pudding before the main course (or paying for either) and as well as spoiling our characters this might explain why the main upward pressure on inflation is now from fruit. Table 2. CPI/RPIX Summary CPI(Formerly HICP) Source Information: National Accounts Represents: All Households, including institutions and foreign visitors. Formula Used: Geometric 2005 Q1 Inflation: 2.0 RPIX Source Information: Expenditure & Food Survey Represents: Excludes richest 4% and those pensioners 3/4 reliant on benefit. Formula Used: Arithmetical 2005 Q1 Inflation: 2.9 ©Max Kalis 2005
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