Sixty Second Summary
LGPS and the consultation on the reform of the RPI methodology
02 Apr 2020
Background
On 11 March 2020, the Treasury published a consultation on the reform to the Retail Price Index (RPI) methodology. The need for reform was proposed a year ago by the UK Statistics Authority (the Authority), which has official oversight of the statistics on UK inflation measures. Whilst the Authority is independent of the government, the consent of the Chancellor of the Exchequer is legally required in this situation, as RPI in its present basis is used as reference rate for index-linked gilts.
The purpose of a public consultation is to inform the Chancellor’s decision to consent to the changes to the methodology. The Consultation seeks the views of relevant stakeholders and market participants on how the proposed changes, if implemented, would affect index-linked gilts and the market for them, as well as the broader economy beyond the remit of the Chancellor or the Authority. The Consultation also seeks views on the best timeframe to implement the proposed changes – no earlier than 2025, to allow time for proper review, but before 2030 when the legal requirement to seek the Chancellor’s consent expires.
Limitations of the current methodology
In the summary of their analysis, the Authority presented their views on the drawbacks of RPI as a suitable measure of inflation, mainly that
- RPI overstates inflation because the statistical properties of the formula used for RPI bias the rate upwards, producing an average annual overestimation of 0.7% compared to the inflation estimate of the formula used by the Consumer Price Index (CPI) and CPI including owner occupiers’ housing costs (CPIH). The formula used for RPI is no longer considered best practice by international standards, as a result, and many countries no longer use it;
- the RPI approach to measuring homeowners’ housing costs is mainly comprised of housing depreciation, which represents approximately 8% of the RPI ‘basket of goods’ and can swing RPI steeply in a housing downturn, and mortgage payments, which do not reflect consumption but the cost of financing consumption;
- and further, the RPI weighting favours the spending of private households, its coverage conditions exclude 12% of demographic households, and it uses a UK-specific classification system that doesn’t lend itself to international comparison.
For more details on the proposed changes and the significance of the consultation, download our full summary.
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