Inflation is measured as the percentage increase in the Consumer Prices Index (CPI) over the previous 12 months. The index is constructed from a basket of goods that is supposed to represent the buying habits of an average UK household. This basket is updated each year as tastes change and as technology moves forward. The basket contains approximately 700 items, with 180,000 individual prices collected each month.
As certain goods become more popular and trends change, the ONS have the responsibility of identifying these changes and updating the basket of goods. The CPI then looks at how the weighted average price of this basket of goods changes from one month to the next. As the CPI gives us the main measure of UK inflation, it is essential that the basket of goods used does represent current consumer demands. If the basket of goods used 20 years ago was still in place, we wouldn’t see thing like mobile phones and ipads being included. This is one sector that has seen significant growth in recent years and the basket of goods has been adapted in response. A new addition to the measure is e-books, which have seen a significant growth in popularity.
However, just as new products have been added to the CPI measure, other goods have been removed. In the most recent update, we’ve seen the removal of champagne and Freeview boxes from the basket of goods. With rapid changes in technological products, such as the ipad, kindle and e-books, products that were new additions only a few years ago are now old news, being replaced by the latest gadgets. Other changes to the basket of goods are less about reflecting consumer trends and more about making certain categories more representative, such as fruits and hot drinks.
So, can the changes in the basket of goods tell us anything about the impact of the recession on buying habits? One notable exclusion from the basket of goods is champagne sold in restaurants and bars. In an economic downturn, you’d expect luxury products to see a decline in consumption and the trend in champagne consumption certainly seems to support the theory. The trends suggest that consumers have instead switched to cheaper alternatives, with things like white rum bought from shops increasing.
Many people may look at the basket of goods and think that it doesn’t reflect what you buy in your average shop. But, the purpose of the CPI is to try to reflect the average consumer and the different items in the basket are given different weightings to give some indication of the amount spent on each good. The articles below look at the changes in the CPI basket of goods and what, if anything, we can take from it.
Inflation basket: E-books added by ONS BBC News (12/3/13)
Inflation basket – what does it say about you? Channel 4 News (12/3/13)
The fizz has fallen flat – champagne cut from inflation basket Independent, Martin Hickman (13/3/13)
E-books added to inflation basket, as champagne dropped The Telegraph, Philip Aldrick (13/3/13)
UK inflation basket: e-books in, champagne out The Guardian, Marking King (13/3/13)
Champagne tipped out of inflation basket Financial Times, Hannah Kuchler (13/3/13)
Champagne out, ebooks in as inflation basket updated Reuters (13/3/13)
Questions
- What is inflation and why is it such an important variable?
- How is the CPI calculated? Is it different from the RPI?
- What impact has technological change had on the basket of goods used to calculate the CPI?
- Can you identify any other economic or business trends from the products that are in and out of the CPI basket of goods?
- Given the importance of technology and the speed of change, do you think the review of the basket of goods should become more or less frequent?
- Has the economic downturn had any effect on the basket of goods used to calculate the CPI?
Inflation is a key macroeconomic variable and governments typically aim for both low and stable rates of inflation. In the UK there are two main measures of the rate of inflation in the UK – the CPI and the RPI. Over the past few years there has been a growing gap between the two measures and this has led to consultations about how the RPI could be adapted to allow it to rise more slowly in the future. (Click here for a PowerPoint of the chart.)
The RPI and CPI measure inflation in different ways – they don’t measure the same basket of goods. The RPI measure includes the costs of housing, whereas the CPI does not include this. Furthermore, the RPI is an arithmetic mean and the CPI is a geometric mean, which will be lower than the arithmetic mean. The ONS says that a key advantage of using the geometric mean (i.e. the CPI) is that:
…it can better reflect changes in consumer spending patterns relative to changes in the price of goods and services.
Typically the RPI has been about 1% higher than the CPI and governments can benefit from this by linking state benefits to the CPI (the lower rate) and payments they receive to the RPI, thus maximising the difference between earnings and expenditure.
However, the gap between these two measures of inflation has been growing and this has been causing concern for the ONS and the Office for Budget Responsibility (OBR). This has led to the consultative process regarding making changes to the RPI. However, any change made to the RPI would put certain groups at a disadvantage. One such group is pensioners – many pensioners in the private sector have their pensions linked to the RPI and if a change were made to bring it more in line with the CPI (i.e. lower it) they would suffer. Ros Altman, director general of SAGA said:
After 30 years of retirement, someone who receives 0.6% lower inflation uprating will end up with a pension nearly 20% lower…Therefore, over time, pensioners will be able to afford less and less and pensioner poverty will increase once again.
There would be some beneficiaries of any change to the RPI – the government would benefit in some areas; company pension schemes might also see gains made; some students might benefit and even rail travellers.
An announcement was made by the National Statistician, Jil Matheson, on the 10 January. Much to the surprise of most experts, she has decided to keep the RPI measure unchanged. She did recommend, however, that a new index be introduced that would be published alongside RPI and CPI. The new index would better meet international standards.
The following articles look at the arguments for and against changing the RPI measure.
Articles prior to announcement
Pensioner backlash expected over pension reform The Telegraph, Philip Aldrick (9/1/13)
Inflation: Changes to the calculation of RPI expected BBC News (9/1/13)
RPI review ‘may hit pensioners’ Express and Star (9/1/13)
Q&A: Inflation changes BBC News (9/1/13)
Pension holders and savers: beware of an RPI inflation change The Economic Voice (9/1/13)
Pensioners and savers face ‘stealth attack’ on their income from change to the inflation index Mail Online (9/1/13)
Articles following announcement
Relief for pensions as ONS says leave RPI unchanged The Telegraph (10/1/13)
RPI review recommends new inflation index The Guardian (10/1/13)
Inflation: No change to RPI calculation BBC News, 10/1/13)
The ONS puts consistency first BBC News, Stephanie Flanders (10/1/13)
Q&A: Inflation changes BBC News (10/1/13)
Announcement by National Statistician
National Statistician announces outcome of consultation on RPI ONS (10/1/13)
Questions
- How are the RPI and CPI measured?
- Why is the RPI typically higher than the CPI?
- What changes to the RPI were suggested? What are the advantages and disadvantages of each?
- Who would have benefited from each of the proposed changes to the RPI?
- Who would have suffered from each of the proposed changes to the RPI?
- Why has there been a growing divergence between the two measures of inflation?
- Do interest rates affect the RPI and CPI measures of inflation to the same extent?
- Which measure of inflation is used for the Bank of England’s inflation target? Has it always been the measure used?
Unemployment is a term that economists and non-economists are familiar with, even if the non-economists perhaps have a less stringent definition of what we term unemployment. Typically, we say you are unemployed if you are of working age and available for work at the current wage rate, but are not in work. Another important and related concept is that of underemployment, which according to the ONS, is a growing problem in the economy.
Latest figures released by the ONS show that just over 10% of all workers in the UK would like to work more hours each week. This is essentially what underemployment is and it typically affects part-time workers who want to move closer to a full-time job, but are unable to find the necessary hours from their employer. As the economic situation in the UK worsened after the financial crisis, unemployment increased rapidly. Some people went from working full-time to part-time and others simply lost their job. As the economy started to stabilize, people began returning to work, but many found that part-time employment was the only option, despite wanting to work many more hours at the going wage rate. As the ONS said:
During this period [the economic downturn] many workers moved from full-time to part-time roles and many of those returning to work after a period of unemployment could only find part-time jobs … Of the extra one million underemployed workers in 2012 compared with 2008, three-quarters were in part-time posts.
The increase in underemployment has levelled off and though the recession has been a key contributing factor to the higher levels of underemployment, it’s important to note that it can be caused by a few things, as outlined by the ONS.
• employers only being able to offer a few hours of work each week
• workers, such as bar staff, being in jobs where they are only required for a few hours a day
• personal circumstances changing so that someone now wants to work more hours than before
• people settling for a part-time job as second-best when they would much rather have a full-time one
Although many people are happy with their part-time jobs and hence would not see themselves as underemployed, for those who are underemployed, the fact that they cannot find sufficient hours seems to indicate an inefficiency within the economy, especially if long-term unemployment or underemployment emerges. This problem is particularly relevant amongst the young and those in low-skilled jobs. However, it is also an increasing problem amongst the self-employed.
The implications of underemployment are far-reaching. Naturally it adversely affects an individual’s financial situation, which at the current time with rising household bills can have devastating consequences. There are also wider effects such as the economic implications in terms of economic growth and inefficiency, as well as a potential increased strain on the tax and benefits system. Given these far-reaching consequences, it is an issue that everyone should be concerned about. The following articles consider the growth of underemployment in the UK economy.
Underemployed workers jump by 1m since financial crisis Telegraph, Rebecca Clancy (28/11/12)
Underemployment affects 10.5% of UK workforce (including video) BBC News (28/11/12)
Economic crash leaves an extra 1million workers under-employed and wanting more hours Mail Online (28/11/12)
UK is underemployed: should we be surprised? BBC News, Stephanomics, Stephanie Flanders (28/11/12)
Unemployment affects 1 in 10 workers, ONS says Guardian, Mark King (28/11/12)
One in 10 workers no underemployed Financial Times, Brian Groom (28/11/12)
Underemployment rises to affect one in ten workers Channel 4 News (28/11/12)
Questions
- What is the difference between unemployment and underemployment? Is one worse than the other?
- Why did underemployment initially begin to rise after the financial crisis and what factors helped to slow the increase?
- How can underemployment be measured? Is it likely to be accurate?
- Part-time work has risen in recent decades, as part of a more flexible labour market. Do you think this is a good thing or does it add to the problem of underemployment?
- What are the economic implications of underemployment? You should think about the effects on an individual, their family, society and the wider economy.
- How can someone who is self-employed be classed as underemployed?
- What action, if any, can be taken by the government to tackle the rising problem of underemployment?
The story of the UK economy over the past few years has been one of bad news and worse news. With a double-dip recession having kept confidence low in the UK, positive news for the economy was seemingly a distant hope of government ministers. However, official statistics show that that in the 3 months from July to September, the UK economy emerged from recession, with growth of 1.0%.
This positive GDP figure (click here for a PowerPoint of the chart below) was undoubtedly helped by the London Olympics over the summer, which may have added as much as 0.2 percentage points to GDP, according to the ONS. Millions arriving in London and other venues, spending money on countless things. Yet, other factors have also contributed to this welcome growth. Stephanie Flanders said:
The positive ‘surprise’ in these figures is largely to be found in the service sector, which is estimated to have growth by 1.3% in the third quarter, after shrinking by 0.1% in the three months before.
Further to this, in Stephanie Flanders’ ‘Stephanomics’, she says that ‘it confirms that the last three months of this latest recession were brought to you by the Queen. Or at least, the extra Bank Holiday to celebrate her Jubilee.’ The Bank of England suggests that the Jubilee took 0.5 percentage points from official GDP statistics. So, the news so far is positive, but the economy is far from being back to its pre-recession size.
The 2008-2009 recession knocked 6.4% off the UK economy. Since then, the total growth (over the past 4 years) has reached only half of that – 3.2% and that includes the 1% figure just published. Thus, while we may be on ‘the right track’, there is still a long way to go. Economists differ in their interpretations of what this means for the overall recovery: some say that this is a sign of what’s to come; others argue that this recovery has been driven by one-off factors.
What is certain is that government policy over the next few months will be crucial in keeping the economy on the right growth path. The following articles consider the implications of this new economic data.
A special recovery BBC News, Stephanomics, Stephanie Flanders (25/10/12)
UK GDP rises 1pc: economist reaction The Telegraph (25/10/12)
Nick Clegg warns economic recovery will be ‘fitful’ The Guardian, Daniel Boffey (28/10/12)
GDP figures set to show UK economy has exited double-dip recession The Telegraph, Philip Aldrick, Emma Rowley and Jessica Winch (25/10/12)
UK economy returns to growth with help from Olympics BBC News (25/10/12)
U.K. posts quarterly gain in GDP, lifted by Olympics Wall Street Journal, Cassel-Bryan Low (25/10/12)
GDP figures show UK emerging from recession: full reaction The Guardian (25/10/12)
UK growth signals move out of recession Financial Times, Sarah O’Connor and George Parker (25/10/12)
Questions
- How do we define a recession?
- How is GDP calculated and what does it measure?
- Which factors have contributed towards lower GDP data towards the beginning of this year?
- Which factors have helped boost GDP in the 3 months from July to September?
- Why is there disagreement about the likelihood of positive GDP figures continuing throughout the rest of the year?
- Prior to the official release of the GDP figures, David Cameron hinted at positive news. Given that the market is so sensitive, what effect might this suggestion have had?
- Given this positive figure, what implications does this have for the government’s quantitative easing programme?
- If we translate this latest growth data onto an AD/AS diagram, how would you show what has recently happened?
Although every recession is different (for example in terms of length and magnitude), they do tend to have a few things in common. The focus of this blog is on consumer income and how it is affected in the aftermath of (or even during) a recession. According to data from the ONS, real national income per head has fallen by more than 13% since the start of 2008.
This latest data from the Office of National Statistics shows that in the aftermath of the 2008 recession, UK incomes have fallen by much more than they did in the 2 previous recessions experienced in the UK (click here for a PowerPoint of the chart). We would normally expect consumer incomes to fall during and possibly directly after a recession, as national output falls and confidence tends to be and remain low. However, the crucial thing to consider with falling consumer incomes is how it affects purchasing power. If my income is cut by 50%, but prices fall by 80%, then I’m actually better off in terms of my purchasing power.
The data from the ONS is all about purchasing power and shows how UK consumer incomes have fallen at the same time as inflation having been relatively high. It is the combination of these two variables that has been ‘eating into the value of the cash that people were earning’. Comparing the incomes in the four years after the 2008 recession with similar periods following the early 1980s and 1990s recession, the ONS has shown that this most recent recession had a much larger effect on consumer well-being. Part of this may be due to the rapid growth in incomes prior to the start of the credit crunch.
It’s not just the working population that has seen their incomes fall since 2008 – the retired population has also seen a decline in income and according to a report from the Institute for Fiscal Studies, it is the wealthiest portion of older households that have taken the largest hit since 2007. According to the IFS, the average person over 50 has experienced a fall in their gross wealth of about 10%, or close to £60,000. Of course for these older households, the concern is whether they will be able to make up this lost wealth before they retire. The concern for everyone is how long until incomes and purchasing power increase back to pre-crisis levels. The following articles consider this latest data on economic well-being and the impact the recession has had.
UK wellbeing still below financial crisis levels Guardian, Larry Elliott and Randeep Ramesh (23/10/12)
National income per head ‘down 13% in four years’ BBC Newsd (23/10/12)
Financial crisis hits UK retirement income Financial Times, Norma Cohen (23/10/12)
Over 50s ‘left £160,000 out of pocket by the financial crisis’ The Telegraph, James Kirkup (23/10/12)
Those near retirement in UK hit hard by crisis Wall Street Journal, Paul Hannon (23/10/12)
Living standards down 13pc since start of recession The Telegraph (23/10/12)
Questions
- Why is net national income per head said to be the best measure of economic well-being?
- Why is it so important to take into account inflation when measuring wellbeing?
- What explanation can be given for the larger fall in consumer incomes following the 2008 recession relative to the previous 2 recessions?
- According to data from the IFS, the richest portion of older households have suffered the most in terms of lost wealth. Why is this the case?
- What is meant by purchasing power?
- GDP has fallen by about 7%, whereas national income per head, taking inflation into account is down by over 13%. What is the explanation for these 2 different figures?
- How can recessions differ from each other? Think about the length, the magnitude of each.
- Is GDP a good measure of economic well-being? Are there any other ways we can measure it?
Inflation is measured as the percentage increase in the Consumer Prices Index (CPI) over the previous 12 months. The index is constructed from a basket of goods that is supposed to represent the buying habits of an average UK household. This basket is updated each year as tastes change and as technology moves forward. The basket contains approximately 700 items, with 180,000 individual prices collected each month.
However, just as new products have been added to the CPI measure, other goods have been removed. In the most recent update, we’ve seen the removal of champagne and Freeview boxes from the basket of goods. With rapid changes in technological products, such as the ipad, kindle and e-books, products that were new additions only a few years ago are now old news, being replaced by the latest gadgets. Other changes to the basket of goods are less about reflecting consumer trends and more about making certain categories more representative, such as fruits and hot drinks.
