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Budgeting for a transformation of the inflation calculation
Will Bennett, a member of the pensions actuarial team in Barnett Waddingham's London office and a graduate in economics and mathematics, looks at comments made in this year's Budget regarding inflation measures.
An aspect of the recent Budget that the press did not cover in any great detail was Gordon Brown's announcement that the government is to change the measure for inflation in the UK from RPIX to an internationally-recognised measure of consumer prices, the Harmonised Consumer Price Index (HCPI).
The Chancellor first alluded to this future change in his maiden Budget speech of 1997 when he spoke of the case over time for moving to a new measure of domestic inflation.
RPIX and RPI
RPIX is calculated in the same way as headline inflation (RPI) except that mortgage and interest payments are eXcluded.
A problem with both the RPI and RPIX measures are that the baskets of goods used to calculate these measures are revised every quarter to reflect changing patterns of consumption. This overstates the rise in the cost of living so pensions that increase in line with RPI allow you not just to maintain the standard of living but also to improve your quality of life by continually upgrading to the latest model in the basket.
HCPI
The HCPI measure uses a different method of calculation to try to overcome this problem. The "harmonised" part of the description refers to the fact that it has been adopted as a common method throughout Europe so that when inflation is measured in different countries like is compared with like.
Gordon Brown
The Chancellor conceded that the RPIX measure is well known and understood, but stated that HCPI is in line with best international practice and is used widely in Europe and every other G7 nation save Japan.
Mr Brown concluded that there is a case in principle for adopting the HCPI measure and that the Treasury will continue to examine the implications of such a change.
Despite this announcement Gordon Brown reaffirmed the symmetrical inflation target of 2.5% based on the current RPIX measure.
For further details on measures of inflation and their respective characteristics, follow the link to Inflation Contemplation.
Will Bennett, April 2003.