By Tarryn Stanhope, Contributor to The London Financial
With current CPI inflation rates at 9.4%, criticisms have emerged over lockdown, and the question being pondered is: is CPI really the best measure of inflation?
What is the Consumer Price Index?
The Consumer Price Index is the predominant index used to measure inflation in the UK and internationally. It works by tracking the change in prices of over 730 retail goods and services over time. This selection of goods and services is determined by the Office of National Statistics (ONS) and aims to reflect the general level of prices for the average consumer. The index along with commercial items such as clothing, electronics, etc. also includes goods bought as a common expenditure from households, such as basic food items, transportation, housing costs, and antibacterial surface wipes.
Has Covid-19 Placed a Mask on CPI Figures?
However, over recent months consumers have begun to notice discrepancies between the CPI level of inflation and the real increases in their costs of living. Problems with the use of CPI to measure inflation arose mainly during the pandemic when consumer spending habits changed drastically. As sections of the CPI are weighted depending on their ‘economic importance’, or the amount of expenditure on each group of items, – when food prices rose over the Covid-19 lockdown, the weighting system did not re-adjust to represent this increase until the beginning of the following year. Transport costs also maintained their weighting, even whilst transport prices plummeted as a result of the ‘stay at home’ measures announced by the British government in March 2020. In 2018, transport had a weighting of 156 parts per 1000, and it was only at the beginning of 2021 that this was lowered to 136 parts per 1000. Therefore, as a result of sudden, unpredictable changes in consumer expenditure, the CPI’s weighting system quickly became obsolete which meant that inflation was largely underestimated.
Prior Criticisms
However, regardless of the lockdown, the index had faced criticisms prior to 2019. Economists evaluated the use of the index and discovered three main pitfalls to the inflation measure: substitutes aren’t weighted equally, product quality is not taken into account, and new products aren’t included in the index.
The CPI can’t account for rapid changes in consumer trends, a shortfall that proved especially problematic over lockdown. Therefore, swaps to cheaper alternate products as a result of rising prices cannot be accounted for as they happen, meaning the index, instead, assumes there is the same quantity of increasingly expensive products being bought. The CPI is a pure price index, and also fails to measure any changes in the quality of goods or services. Meaning, for example after the sugar tax was introduced in April 2018, as prices did not change, shrinkflation was not taken into account, and therefore even if a consumer’s marginal utility fell, the CPI remained the same. Therefore, the CPI only reflects changes in price, without factoring in any additional benefits or drawbacks to consumers.
CPI also inherently favours the urban consumer due to its weight on expenditure. As much of the UK’s population lives in urban areas (82.9% of England’s population in Mid-2020), the index tends to emphasise the average spending by city populations, rather than those in rural areas – whose spending differs largely. Therefore, a drawback of the CPI is it does not mirror different demographic’s needs equally, meaning the 9.7 million people in England living in rural areas, whose inflation rate may be up to 20% higher than that of urban areas (due to increased transportation, housing, and energy costs) are not represented by the CPI index.
CPI also makes use of sampling and is inherently going to encounter the same problems associated with being a general measure of inflation – such as not being representative of every change in price and not representing every good bought in the British economy. CPI acts as a measure of a typical household’s spending, and over recent months the index and ONS have attempted to better represent the general consumer by increasing the weighting of energy and fuel prices. This change in weighting, however, is slow- and new products that enter the market cannot be included in the index immediately, allowing for mis- measurements of inflation in the short term. However, these mis-measurements are minor (at one product), and the ability to change the weightings of goods and services in the index does provide the CPI with flexibility that has – other than in the pandemic – allowed the CPI to stay accurate and relevant to current trends in consumer behaviour.
Alternate Methods of Measuring Inflation
Before it lost its status as a National Statistic in 2013, the Retail Prices Index was the main measure of inflation used in the UK. However, the ONS released a statement in 2018 saying their “position on the RPI is clear: we do not think it is a good measure of inflation and discourage its use”. This is because the RNI ran around 0.7% higher than the current CPI measure due to the formula used to produce the RPI failing to meet international standards. In the chart below (available on the ONS website), the RPI continued to run higher than the CPI due to the “formula effect”, the inclusion of house prices and mortgage interest payments, and the reliance on small sample sizes for RPI weightings.
The CPIH is also in use currently and acts as an extension to the CPI to include measurements of the costs associated with house maintenance and ownership, such as Council Tax.
No nationwide index will be able to reflect every individual’s cost of living. Although the CPI has some drawbacks, it still offers the largest insight into the true level of inflation affecting consumers around the UK. The ONS has identified these shortcomings and already adjusts the weightings annually to make changes in consumer tastes into account. Therefore, regardless of its drawbacks, CPI remains the most accurate measure of inflation in the UK economy and is used alongside other measures, like the CPIH, to ensure all categories of household expenditure are taken into account. It shows that, for a majority of cases, any rise in costs experienced by households is measured and is reflected in the figure released by the Bank of England every month.