1. Towards a Household Inflation Index (HII) – part 1 JOHN ASTIN AND JILL LEYLAND Presentation to the RPI CPI User Group public meeting – 13 th July 2015

2. Outline of presentations Background and why an HII? Basic principles Owner Occupied Housing Expenditure weighted vs Household weighted Mortgage Interest and other loan interest Insurance RPI CPI User Group 2

3. Background - why an HII RPI CPI User Group 3

4. Source: government data as quoted in A. Bowley: Prices and Wages in the United Kingdom, 1914-1920 “ Cost of living” index started in 1914 to measure high inflation during WW1. Aimed at “meeting basic welfare needs of the working classes”. RPI CPI User Group4

5. Aims evolved but still household focused Interim Index of Retail Prices (1947- 56): “representative of the spending habits of wage earners and those in receipt of small salaries” Retail Prices Index (1956- ): “average price changes for households which would include practically all wage earners and small and medium salary earners.” RPI CPI User Group 5

6. RPIAC* report, 1986, summarised 7 uses a)For assessing changes in the standard of living of consumers; b)for monitoring the effectiveness of counter-inflation policies; c)for calculating the purchasing power of after-tax incomes, interest payments, etc; d)for deflating statistics of the value of retail sales in order to derive estimates of the volume of sales; e)for uprating social security benefits, state pensions, the capital value of some National Savings and gilt-edged securities, and the level of tax thresholds; f)for providing proxy measures to stand for more specific price indicators, for example to index- link compensation payments or amounts covered by insurance; g)for pay bargaining * Retail Prices Index Advisory Committee RPI CPI User Group 6

7. But then came inflation targeting First used 1990 (New Zealand) 1992 (UK) Changed focus – additional needs for RPI; RPIAC struggled to reconcile them Meanwhile HICP was developed for EU macroeconomic purposes RPI CPI User Group 7

8. Current situation RPI, widely used, but technical issues, no longer a national statistic. Limit on changing compilation means not viable for the long term (although it will take a long time to disappear). No major changes since mid-1990s RPIJ, same but without the technical issues CPI (UK HICP) government preferred measure, macroeconomic focus. Not generally used for uprating etc in most other EU countries CPIH – as CPI with owner occupied housing proxied by rental equivalence. RPI CPI User Group 8

9. What is wrong with CPI and CPIH? For macroeconomic purposes only OOH, some formula issues But for measuring inflation from household perspective: do not track OOH (owner occupier housing costs) properly give more weight to wealthier households’ spending do not include loan interest include foreign tourist spending in UK but not UK residents’ spending abroad do not include Council Tax include only a small part of insurance premiums not compiled from perspective of individual household RPI CPI User Group9

10. Principles RPI CPI User Group 10

11. Aims inflation “as experienced and perceived by households in their role as consumers” “cost of goods” All items “to satisfy needs and wants” in scope Long term important Payments basis when substantial difference with acquisition ECOICOP with some additions But for many items similar to RPI/CPI RPI CPI User Group 11

12. Another extract from 1986 RPIAC report “Underlying much of our reasoning in this report is the firmly-held view that it is important to sustain and promote public confidence in the RPI. For the index to be of value it must be generally regarded as relevant to people’s concerns and a fair reflection of their experience. This is partly a question of Presentation - ensuring that results are readily accessible and understood - but it also concerns the methods of compilation. For the index to carry conviction these should be understandable and seem reasonable to “the man in the street” as well as to professional analysts or academic experts. Therefore, while we have consciously sought to clarify the concepts and principles underlying the index in a way which is intellectually rigorous, we attach equal importance to the simple test of public acceptability.” RPI CPI User Group 12

13. Two other things Subdivisions to be calculated for different population groups as needed Our proposals differs from Johnson’s household indices in a number of ways Two things we will not talk about Formula effect: vitally important and needs more research but affects all indices. RPIJ formulae “least worst” starting point Quality issues – important; could be treated differently in HII to CPI/RPI. But many issues around quality, some highlighted by Johnson review RPI CPI User Group 13

14. Owner Occupied Housing (OOH) RPI CPI User Group 14

15. OOH approaches Rental equivalence (CPIH) fine for national accounts, in economic theory – but hardly reflects real life Net acquisitions – “state of the art” approach for macroeconomic indices. Excludes land; weights only reflect housing new to the household sector RPI - mortgage interest included since 1970s. Depreciation added in mid-1990s as proxy for renovation costs RPI CPI User Group 15

16. OOH – our proposal Every cost an owner occupier has is potentially included: Mortgage interest Down payments and mortgage capital payments Repairs and maintenance Renovations and extensions Estate agent, surveyor and legal fees, stamp duty Insurance of dwellings and mortgage protection premiums RPI CPI User Group 16

17. But isn’t house purchase an investment? In part – but shelter a necessity; housing major element in household spending Choice usually made primarily for practical needs “Investment” or “keeping up with housing market” Investment often only realised late in life or at death Semantics or belief in national accounts definitions confuse Should people be “rewarded” by having income raised when asset value increased? – link tenuous Decision not straightforward but too important to exclude RPI CPI User Group 17

18. Down payments, mortgage cap, costs – 2 proposals First time buyers only First time buyers face full weight of any house price rise Separate house price index already exists All buyers Weight given to second and subsequent purchase determined on cost net of money received for existing home (analogous to car purchase) In both cases much more thinking needed but importance of subject merits it RPI CPI User Group 18