The Retail Price Index (RPI) is a famous statistic used to track inflation in the UK. It tracks all household spending, not just retail spending. The RPI has become outmoded: since 2013, it is no longer regarded as an ‘official statistic’ by ONS. For most purposes it has now been replaced by the Consumer Price Index (CPI).
Why is it still published? There are many legal contracts, bonds and debt whose terms and conditions require the RPI to be used as the method of adjusting for inflation. The RPI measure of inflation may well exaggerate the actual level of inflation because of the way it is calculated. The CPI method is now used by most countries, so there is an advantage when making inter-country comparisons in using the same method as others. Internationally the CPI is known as the Harmonised Index of Consumer Prices (HICP).
The methods used to calculate the Consumer Price Index (CPI) are pretty similar to the old RPI, but with some important differences. From month-to-month and year-to-year the aim is to find out how much extra money a household needs to keep up with inflation when buying the same goods as they did before. To do this the Office for National Statistics (ONS) needs to have two data sets: what households purchase and the actual price of these goods.
Price Data.The prices of goods and services purchased by households is found by collecting 180,000 prices for around 700 items each month. Data are collected regionally and nationally in 140 locations to take account of local differences in price movements. The items have to be ‘representative’ of a category (eg garden spades are part of ‘gardening products’) represent at least £400m of annual consumer spending or a particular type of spending (eg acoustic guitars): these are reviewed annually and change with tastes, prices and technology. Three hundred thousand quotes are collected monthly reflecting owner-occupiers’ housing costs.
Mapping Changing Consumer Trends. We do not buy the same collection of merchandise year after year. Changes in the ONS basket reflect consumer trends. In 2009 for example, in came rosé wine, rotisserie chicken, Freeview boxes, mp4 players, online DVD rental, Parmesan cheese, double cream and free-range eggs. Ten years later in 2019, in came smart speakers, single dinner plates (people do not buy crockery sets any more), baking trays and popcorn: and out went hi-fi systems, three-piece suites, dry dogfood and washing powder. The ONS are not suggesting that three-piece suites, dry dogfood and washing powder are no longer purchased by anyone or are any less important, but that the category can be accurately be measured by the higher expenditure of individual sofas, liquid detergent and dog treats.
Naturally people’s spending habits change and the composition of the basket of items has to change. If people are continually ‘moving upmarket’ then they will purchase different and more expensive products and this will impact inflation calculations. Technological change can produce the opposite effect: constantly changing models and improved performance means that people are buying not the same goods at a different price but a superior item. Disentangling the effects of better technology from higher prices is difficult.
The ONS have faced increasing problems from heavy price competition in the retail industry. There no longer is a standard price for half of items they sell because most stores provide rapidly-changing offers and price reductions. Fast fashion has also been problematic because most merchandise is only available for a few weeks, so it can be hard to track the same (or similar) item over a twelve-month period.
As a matter of policy the ONS takes no account of offers or price reductions that are not available to all consumers. This will overstate actual inflation unless some attempt is made to adjust prices for limited offers weighted by the numbers who use them. Yesterday I shopped at Waitrose using a coupon that gave me £14 off a shopping basket of £70 or more. That £70 bundle of groceries, cheese, chicken, cream, wine, salad etc only cost me £56, but would be recorded by the ONS as a £70 purchase. This seems perverse. And the ONS has been slow to make use of web scraping (automatically collecting internet data) to take account of the constantly-changing prices on the internet.
Category data: What households buy. The ONS uses expenditure surveys to calculate what households actually spend their money on, both the total spent and the breakdown by category (food, alcohol and tobacco, clothing and footwear, furniture and household goods, communications, restaurants and hotels, housing, etc). This spending is used to weight each category that that the average price increase for each category can be used to make the final overall CPI result. Separate indices are created for regions, age groups and demographic groups.
Slight differences are seen in CPI compared to RPI. RPI includes owner-occupier housing costs, but limits its calculations to UK households only (the CPI includes tourist spending) and excludes the two extremes of highest-income households and pensioner households that are mainly dependent on state benefits.
The CPI excludes owner-occupier housing costs like as mortgage payments, estate agents’ fees, housing depreciation and council tax (which are included in RPI). However a relatively new index, CPIH, does include owner-occupier housing costs, but is not used for adjusting for inflation. It is still being tried out.
The CPI uses a different mathematical formula from the RPI to calculate changes in the index. The old Carli formula (used by RPI) to calculate arithmetic averages for price changes is not used by any of the 30 advanced countries surveyed by the ONS, because it tends to exaggerate any upward trend and does not return to base if the price increase is reversed. Instead the CPI uses a geometric average which is more suitable where indices are serially correlated (as price indexes often are), is more stable and generally rises at a slower rate than the arithmetic average.