This week, we have seen some major potential changes in the UK’s welfare state. One key change involves child benefit. (see Who won’t benefit from child benefit?) However, a more recent development stems from a problem that has built up over a number of years and is not just peculiar to the UK: Pensions.
As technology advances and medical procedures improve, there has been a general increase in life expectancy for both men and women across the world. People are living for longer and longer and hence pensioners can be in retirement for over 30 years. This is over double the retirement time we used to see decades ago. Therefore, pensioners are eligible to receive their state pension or their private pension for much longer and hence the cost is becoming unsustainable.
Lord Hutton has led a review into public sector pension schemes and has concluded that public sector workers should be paying higher contributions. Lord Hutton has said that employees should be working for longer and hence retiring later. This would increase their contributions throughout their lives and also reduce the time period over which they receive a pension, hence cutting costs. There was also a recommendation that ‘final-salary pension schemes should be scrapped and changed to so-called ‘career-average’ schemes. The final-salary scheme benefits high earners and not those who make gradual progression up the career ladder. This possible change should certainly reduce the pension you are eligible to receive and hence should positively affect the sustainability of pension provision in the UK.
However, public sector workers who may face higher contributions and have already, in some cases, faced pay cuts or pay freezes, are unsurprisingly upset. They argue that accepting work in the public sector means accepting a lower wage than they could achieve in the private sector. The compensation, they argue, is the reward of a higher pension, which could be about to change. However, the independent review has found that the contributions made by the public sector do not reflect the true cost of the benefit they receive in their pension. This is likely to be a contentious issue for some time to come. Below are some articles considering this, but keep a look out for further developments.
Articles
Public sector pensions report explained BBC News (7/10/10)
Public sector pensions review: Q&A Telegraph (9/10/10)
Pensions reforms to focus on high earners Independent, Simon Read (9/10/10)
Why Lord Hutton could make public pensions bills bigger … not smaller Financial News, Mark Cobley and William Hutchings (8/10/10)
Lord Hutton: I busted the myth that public sector pensions are gold-plated Telegraph, Lord Hutton (8/10/10)
Key points of UK public sector pension review Reuters (8/10/10)
Public pensions review recommends higher contributions BBC News (7/10/10)
Public sector workers paying ‘less tax’ due to generous pension rules Telegraph, Myra Butterworth (8/10/10)
Asda closes final salary pension scheme Telegraph, Jamie Dunkley (9/10/10)
Hutton report: he’s no friend of gold-plated pensioners Guardian, Patrick Collinson (9/10/10)
Asda to close final salary pension scheme BBC News (8/10/10)
Lord Hutton: what the pension revolution means for public servants Telegraph, Emma Simon (8/10/10)
Report
Independent Public Service Pensions Commission: Interim Report Pensions Commission, Lord Hutton October 2010
Questions
- What is the purpose of a pension? Think about the idea of redistribution.
- Why should average-career pension schemes be less costly than final-salary pension schemes? Which is the most equitable arrangement?
- What are the key problems that have led to the pensions problem in the UK?
- What are the main recommendations of the independent pension review?
- How is opportunity cost relevant to problem of pensions provision?
- Is it fair that public sector workers should pay higher contributions towards their pensions?
- The BBC News article, Public sector review recommends higher contributions states that: “The recent decision to uprate pensions in line with the consumer prices index (CPI) rather than the retail prices index (RPI) has shaved 15% from the cost of the schemes.” Explain why this is the case?
The consumer prices index (CPI) is used by the government and the Bank of England for measuring the rate of inflation, and in the 12 months to March 2010 it rose by 3.4%. This figure was above the expected rate of 3.1% and well above the Bank of England’s target of 2%. The other major measure of consumer prices, the retail prices index (RPI) rose by even more – by 4.4%.
In order to recover from the recession, the UK economy needs to grow, but as demand begins to rise, this could put further upward pressure on inflation. There are a number of influencing factors that have caused the recent rise in inflation (see Too much of a push from costs but no pull from demand). Large rises in housing, fuel, transport, many household services and food were contributing factors. Many of these factors, however, are thought to be temporary, so it may not be too much of a problem.
And anyway, at least if inflation does continue to rise, it won’t be unexpected!
Articles
UK inflation rate rises to 3.4% BBC News (21/4/10)
A surprise? Definitely. A problem? Possibly. BBC News blogs, Stephanomics, Stephanie Flanders (20/4/10)
Transport costs push UK inflation above 3pc Telegraph, Edmund Conway (21/4/10)
Data
Latest Inflation data National Statistics Online
Consumer Price Indices portal National Statistics Online
Consumer Price Indices, Statistical Bulletin Office for National Statistics
Consumer Price Indices, time series data National Statistics Online
Retail Prices Index: 1948–2010 National Statistics Online
Questions
- Why might the Monetary Policy Committee have to restrict growth to keep inflation manageable?
- What are some of the causes of rising inflation? Why are expectations so important?
- How is the CPI calculated to measure inflation?
- Normally, during a recession, we would expect economic growth to be poor, but inflation to be low and stable. How can we explain both poor growth and rising inflation?
- “Investors know that the UK government has more to gain from an unexpected bout of inflation than almost any other economy.” Why is this?
The latest inflation numbers are a joy for headline writers! With the falling price of toys, we can perhaps speak of ‘inflation toying with us’, while the fall in the cost of gas might allow us to say that ‘gas takes the fuel out of inflation’. More generally, the latest inflation figures from the Office for National Statistics (ONS) show the annual rate of CPI inflation falling from 3.5% in January to 3% in February. In other words, the weighted price of a representative basket of consumer goods and services rose by 3% in the 12 months to February as compared with 3.5% over the 12 months to January.
In compiling the Consumer Price Index (CPI), the ONS collects something in the range of 180,000 price quotations over 650 representative goods and services. These goods and services fall into 12 broad product groups. The items to be selected for these groups are reviewed once a year so that, in the face of changing tastes and preferences and changes in the goods and services available to us, the ‘CPI shopping basket’ remains representative. A price index and a rate of price inflation are available for each of these 12 broad groups as well as for goods and services within these groups. So, for instance, we can obtain a price for ‘transport’, then, within this group, we can obtain a price for the purchase of ‘vehicles’ and, finally, a price for ‘new cars’ and for ‘second-hand cars’. This level of detail also means that individuals can calculate their own personal inflation rates using the ONS personal inflation calculator.
So what of the latest fall in the rate of CPI inflation? Well, the ONS reports ‘widespread’ downward pressures. This phrase needs some careful unpicking. Downward pressure is reported from ‘recreation and culture’ because its average price was static in February, but rose a year earlier. Within this group, the average price of games, toys and hobbies fell this year, but increased a year ago and, so, our possible headline ‘inflation is toying with us’. Similarly, downward pressure is reported from ‘housing and household services’ where a fall in its average price this year follows static prices a year ago. A major driver of this change was a reduction in average gas bills and so our other possible headline, ‘gas takes the fuel out of inflation’.
The latest price numbers from the ONS show that some product groups are experiencing long-term price deflation. For instance, while the average price of ‘clothing and footwear’ actually rose in February, when we analyse annual rates of price inflation for this product group, one has to go back to March 1992 to find the last time it was positive! Indeed, within the slightly narrower product group of ‘clothing’, the average annual rate of price deflation over the past ten years has been 6.1%. A similar longer-term trend of price deflation can be found in the product group ‘audio-visual, photo and data processing’. Here there has been an average annual rate of price deflation of 9.9% over the past ten years. So, smile for the camera!
Articles
Rates set to remain at record low as inflation falls back sharply heraldscotland, Ian McConnell (23/3/10)
Inflation data boosts government before budget AFP (23/3/10)
UK inflation rate falls to 3% in February BBC News (23/3/10) )
Inflation slows more than expected Reuters UK, David Milliken and Christina Fincher (23/3/10)
UK inflation falls sharply to 3% Financial Times, Daniel Pimlott (23/3/10)
Inflation rate fell to 3 per cent in February Independent. James Moore (24/3/10)
Inflation falls back to 3% Guardian, Philip Inman (23/3/10)
How soon before we scrap the Bank’s inflation target? Telegraph, Edmund Conway (23/3/10)
Data
Latest on inflation Office for National Statistics (23/3/10)
Consumer Price Indices, Statistical Bulletin, March 2010 Office for National Statistics (23/3/10)
Consumer Price Indices, Time Series Data Office for National Statistics
For CPI (Harmonised Index of Consumer Prices) data for EU countries, see:
HICP European Central Bank
Questions
- Explain the difference between an increase in the level of prices and an increase in the rate of price inflation.
- The annual rate of price inflation for clothing in February was -3.9%. If the average price of clothing was cheaper, year-on-year, how could it have exerted ‘upward’ pressure on the overall rate of CPI inflation?
- What factors might help to explain why, over the past 10 years, the average annual rate of price inflation for audio-visual, photo and data processing equipment has been -9.9%?
- What factors might help to explain why, over the past 10 years, the average annual rate of price inflation for clothing and footwear has been -5.7%?
- What factors might help to explain why the annual rate of ‘new car’ price inflation was 5.4% in February 2010 compared with -0.2% in February 2009?
- What factors might help to explain why the annual rate of ‘second-hand’ car price inflation was 19.0% in February 2010 compared with -15.1% in February 2009? And, are you surprised at the difference in the rates of ‘new’ and ‘second-hand’ car price inflation?
Inflation’s rising again! After a year of falling inflation, with CPI inflation being below the Bank of England’s target of 2% since June 2009, inflation began rising again in October 2009 and then shot up in December. In the year to November 2009, CPI inflation was 1.9%. In the year to December it had risen to 2.9% – well above the 2% target. As the National Statistics article states, however:
This record increase is due to a number of exceptional events that took place in December 2008:
the reduction in the standard rate of Value Added Tax (VAT) to 15 per cent from 17.5 per cent
sharp falls in the price of oil
pre-Christmas sales as a result of the economic downturn
These exceptional events led to the CPI falling by 0.4 per cent between November and December 2008 (a record fall between these two months). The CPI increase between November and December 2009 of 0.6 per cent is far more typical (the CPI increased by 0.6 per cent between November and December in both 2006 and 2007). These exceptional events also affected the change in the RPI annual rate.
So what should the Bank of England do? 2.9% is well above the target of 2%. So should the Monetary Policy Committee raise interest rates at its next meeting? The answer is no. Although inflation is above target, the Bank of England is concerned with predicted inflation in 24 months’ time. Almost certainly, the rate of inflation will fall back as the special factors, such as the increase in VAT back to 17.5% and earlier falls in VAT and oil prices, fall out of the annual data.
What is more, the sudden rise in CPI inflation is almost entirely due to cost-push factors, not demand-pull ones. Rises in costs have a dampening effect on demand. Raising interest rates in these circumstances would further dampen demand – the last thing you want to do as the economy is beginning a fragile recovery from recession.
The Bank of England’s policy recognises that the prime determinant of inflation over the medium term is aggregate demand relative to potential output. For this reason it doesn’t respond to temporary supply-side (cost) shocks.
Avoid false alarm over UK inflation Financial Times (20/1/10)
Oh dear. Inflation is back again Telegraph, Jeremy Warner (19/1/10)
Mervyn King confident on inflation target Times Online, Grainne Gilmore (19/1/10)
How should we remember 2009? As the year the Bank of England’s inflation target died Telegraph, Jeremy Warner (20/1/10)
An embarrassing bungee-jump The Economist (21/1/10)
Priced in BBC News, Stephanomics, Stephanie Flanders’ blog (19/1/10)
This MPC is not fit for purpose New Statesman, David Blanchflower (21/1/10)
Jobs joy takes sting out of inflation misery Sunday Times, David Smith (24/1/10)
For CPI inflation data, see Consumer Prices Index (CPI) National Statistics
Questions
- For what reasons might inflation be expected to fall back to 2% later in the year?
- Does the rise in inflation to 2.9% put pressure on the Bank of England’s Monetary Policy Committee (MPC) to raise interest rates? Explain why or why not.
- What factors is the MPC likely to consider at its February meeting when deciding whether or not to embark on a further round of quantitative easing?
- What effects has the depreciation of sterling had on inflation? Explain whether this effect is likely to continue and what account of it should be taken by the MPC when setting interest rates.
- What is meant by ‘core inflation’? Why did this rise to 2.8% in December 2009?
- What is the role of expectations in determining (a) inflation and (b) real GDP in 24 months’ time?
- Why, according to David Blanchflower, is the MPC not ‘fit for purpose’?
CPI inflation in the 12 months to September 2009 fell to 1.1% (from 1.6% in the 12 months to August). RPI inflation for the same period was -1.3%. In other words, retail prices actually fell by 1.3% in the 12 months to September. According to the ONS, “By far the largest downward pressure affecting the change in the CPI annual rate came from housing and household services. This was principally due to average gas and electricity bills, which were unchanged between August and September this year but rose a year ago when some of the major suppliers increased their tariffs.” (See below for link.)
If the CPI inflation rate falls below 1% (or rises above 3%), the Governor of the Bank of England is required to write a letter to the Chancellor of the Exchequer explaining why and also what the Bank of England intends to do about this. The Bank of England targets the forecast CPI inflation 24 months’ hence and attempts to achieve a rate of 2%. Normally, if the forecast rate is below 2%, the Monetary Policy Committee will decide to cut the rate of interest. The last Bank of England Inflation Report (August 2009) forecast CPI inflation of around 1.5% in 24 months’ time. If the November Inflation Report forecasts a similar figure, or even below, what can be done? Bank Rate is already at a historic low of just 0.5% and a further cut is unlikely to have much effect. Should the Bank of England, then, engage in another dose of quantitative easing? Perhaps the letter, if it has soon to be written, will make it clear.
UK consumer price inflation at 5-year low BusinessWeek (13/10/09)
Recession helps push inflation to five-year low Independent (14/10/09)
Inflation falls to lowest in five years Guardian (13/10/09)
Inflation dip likely to be short-lived Guardian (13/10/09)
Deflation, not inflation would be the bigger threat if the Conservatives do what they say Jeremy Warner blog, Telegraph (13/10/09)
Pound hit by falling UK inflation BBC News (13/10/09)
Pound hit by falling UK inflation (video) BBC News (13/10/09)
Pound pays price as inflation slides to five-year low Times Online (14/10/09)
Investors weigh risks of inflation and deflation Financial Times (12/10/09)
Wage ‘catch up’ for public sector BBC Today Programme (14/10/09)
Current data on UK Inflation (National Statistics)
Time series data (annual, quarterly and monthly) on UK prices and inflation Economic and labour Market Review (National Statistics)
Questions
- Why did the annual rate of CPI inflation fall so much in September 2009?
- Is the Bank of England Governor likely to have to write a letter (or letters) to the Chancellor in the coming months? Explain why or why not. What is likely to be the role of expectations in determining whether a letter has to be written?
- Why did the sterling exchange rate fall on the announcement of the inflation figure? What are likely to be the effects of this? What will determine the size of these effects?
- Why may additional amounts of quantitative easing be necessary in the coming months? How would a contractionary fiscal policy affect the desirability of additional quantitative easing?