Housing reflation and housing inflation – Alternative inflation …

As this is being written, in 2012,  squeezed living standards have been the norm in the UK now for a good many years. The lastest news indicates apparently that the global downturn is taking the pressure off food and energy prices.

Rental prices for housing are still edging upwards although purchase prices are subsiding, and it is only the inflow of Greek and Chinese money into the upper end of the London housing market that is hiding this in national figures.

With our ‘double-dip’ recession the coalition government is now talking about using house purchase and house building to look to return us to some sort of ‘growth’. Whether in the coming years this will ease or increase the inflationary pressures on the population, would be clearer to all if we had an inflation index in this country that properly took housing, and especially owner-occupied housing, properly into account.

New Inflation Indices

House price inflation in this country has always tended to become apparent in one part of the country before going on to become a general phenomenon. And it affects some social strata before going on to affect everyone. That is why we have been calling for regional inflation indices in the UK and indices that follow the fortunes of different types of households. However, none of these indices would be any good unless housing was properly factored into these figures.

The Office for National Statistics (ONS) is currently doing a consultation on these issues. They are consulting on the formula for owner-occupied housing and the regional issue at the same time. You might have heard of the consultation on owner-occupied housing, but you will not have heard about the consultation on regional indices because it takes the form of a few sentences on the last but one page of  the document on the housing issue. And it says – let’s just forget about them.

This is something worthy of Sir Humphrey Appleby, the satirical character from the 1980s BBC comedy, who was endlessly inventive at stopping anything happening that he did not want to happen. Indeed earlier in his career, Appleby might well have helped kill off the idea of regional inflation indices, when in the early 1970s Whitehall decided not to follow the rest of the developed world, and much of the less developed world, in establishing them.

…so that things remain the same.

Sir Humphrey has also been involved in framing what we are being offered as a new national inflation index that will include housing inflation, and owner-occupation inflation especially. Over a year ago they were offering us a choice of 2 indices. But when you looked at them closely there was no significant difference between them. Below you will see a chart which shows these two choices. It is a very busy chart. The green and the purple lines represent the two ways of including owner-occupied housing  that were being considered until early this year.

The green line is the index that the ONS wants to use and is currently asking approval for. It is the line that is closest to the black line that is the current Consumer Prices Index. Indeed for most of the time shown here you will barely be able to tell them apart.  However neither the  green nor the purple index are significantly different to the current black index.

When inflation exceeds 3%,  the Bank of England can no longer deny a problem and must write to the Chancellor to explain it and what they are going to do. None of the indices in the chart above compel any such attention before food and energy prices create pressure during the final years of the noughties. None of these indices would have triggered an alert at 3 % during the UK house price boom which is shown at its most accelerated in 2003 –  indicated by the additional blue line on this chart. Indeed you can see house prices are actually falling (notice the scale on the right) when the indices cross the 3%  letter-writing  point.

However, the Sir Humphrey consultation document does not ask readers whether they think these problems might make these indices unfit for purpose. Instead the consultation asks a whole series of very technical questions that could be guaranteed to provoke the rival camps among statisticians that have variously been championing the green and the purple.

               

 Can you see the bubble ?

Indeed,when you say that the house price bubble should make some significant  presence in these figures for the early 2000s, the ONS says – well it is not a house price index. However, when you look at the US Consumer Price Index over the last decade, their house price boom is visible in that.

Very specifically the impact of the infamous US house price bubble is visible in the weights of the housing components of the US CPI.

This can be seen in the chart shown immediately below. The weight given to what they term ‘Owners equivalent rent of primary residence’  can be seen here  (in the red columns). It rises from 20%  as the US house price boom took off from 2001.  Had the price rise only been in line with either general inflation or popular incomes, this item would not have needed to be enlarged as a factor in US consumer price inflation.

But over the period 2001-2005, US average house prices rose by about a third in relation to median/average US incomes.  So this item came to play a bigger role than before in driving the US inflation indices up to levels that would provoke the US Federal Reserve to take action to address this by increasing interest rates. (It is now down to where it was in 2002 – as can be seen by scrolling down the current weights.)

Not in no UK index

The black columns are the weights that our UK Office for National Statistics wants to use in their new UK Consumer Price Index as they would be felt during the same period of our even bigger house price boom. They only go up from just over 10% to just under 11% of the index during this period.

This failure to properly pick up the housing inflation in the weights is why the ONS chart we have already displayed fails to pick up our even bigger UK house price boom in any significant way. We have previously quantified this boom from the particular standpoint of the West Midlands. Over the period 1997 to 2007, UK house prices doubled in relation to income. But any increase in the weights in the ONS’ proposal is barely visible, even if we charted the figures back to 1996.  That the weights are less than half the weights in the US index is a further flaw, because during all the period shown in our chart, house prices have been far higher in relation to income in the UK then in the US.

What should the ONS do now ?

The best thing is for the ONS to go back to the drawing board and sort out some proper weights for the new index.  To go ahead with this deeply flawed index, even as an interim measure, would be pointless given that it is basically the same as the existing CPI in most important respects. Worse, to go ahead with this index would give the public the impression that housing in the inflation index is a problem that has been solved, when it has not.

It is clear that the index the ONS is proposing, had it been available 10 years ago, would have done nothing to make the UK’s entrapment in house price inflation and huge private debt any less likely to have happened.  The doubling of UK house prices in relation to incomes was only brought to an end because interest rates around the world began to head upwards, when the US Federal Reserve began to push them up as their house price bubble began to be a problem in their index that could not be ignored. UK house price inflation was brought to a halt by the action of the US system –  not our own.

It was as if they put their brakes on, and because we had no proper controls over our system, we went straight into the back of them. How much better it would have been if we had had an index that had prompted us to damp down our house inflation before the Americans. Then we would not have ended up in this transatlantic pile up when they acted on theirs.

Andrew Lydon

LWM Regional Prosperity & Inflation Project

Our mythical low interest rates – Alternative Inflation Report

With inflation now clearly established above the 2% target – in defiance of the hopes of the Bank of England – most commentators are now expecting interest rates to rise in the months to come.

Interest rates paid by UK households are, however, already some of the highest in Europe, despite all the talk of record lows you will hear from the mainstream media. Here are our average mortgage rates compared to the sick men of Europe as well as Germany:

This is despite the UK Base rate being 0.5%, and the Main rate set by the European Central Bank being twice that at 1.0%.

The record lows are what the banks are paying to savers. As can be seen here against the same countries and sourced from the ECB Data Warehouse (to which the Bank of England contributes the UK figures).

Squeezing borrowers and paying so little to savers is the main reason why the banks are currently losing less money and paying out bonuses again. But the consequence is that the wider UK economy is not recovering unlike most of the rest of the world economy. A more up to dates comparison can be found here.

The need to boost the Sterling exchange rate

If more people and businesses with savings brought them into the Sterling economy, the Pound would recover from its prolonged weakness, and this would bolster the purchasing power of everyone in the Sterling economy in buying food and energy in the international markets. This is the way in which increasing interest rates for savers helps to bolster UK living standards and domestic consumption/employment.

To do this while discouraging abrupt increases in outgoings for borrowers, would require the Bank of England and the Treasury to urgently revise how the Bank of England ‘Base Rate’ is used as guidance. And this is a revision that is now well overdue.

Some might object that the sagging value of the Pound holds down our export prices. Twenty years ago when David Cameron was a Treasury special advisor, manufacturing accounted for about 25% of UK employment. And devaluation did launch the employment boom after the Pound fell out of the European Exchange Rate Mechanism in 1992.  But now manufacturing is just under 10% of employment, even in an old heartland like Birmingham. So gains or losses in manufacturing employment would need to be two and a half times as large to have an effect with any similarity to what happened while David Cameron was working for Chancellor Lamont .

So any monetary policy other than safeguarding domestic living standards makes less sense than ever before. Especially as the sort of inward investment in manufacturing that we saw after 1992 from the silicon chip industry, Toyota and even BMW is not happening now.

Getting inflation in proportion

Other major G7 countries are managing inflation better than we are. They measure it better. They measure it as it impacts upon different parts of their countries and social structure – something we want to see done here in the UK and are currently pressing for. This has allowed inflation to be long-term suppressed by more painstakingly proportionate decisions.

The USA gives out the most comprehensive set of inflation figures every month. This month the CPI-U, representing the broad urban population, is  2.1% .  But it also gives a CPI-W figure for ‘urban wage earners and clerical workers’ which this month is  2.3 %. But they don’t just give a national figure for each of these populations. They also give a CPI-U figure and a CPI-W figure for most of their big cities and the US census regions.

This has made the USA very sensitive to emerging inflation and has prompted the USA to be one of the world’s lowest inflation economies.  A worker in Chicago and the Mid-West knows whether his prices are rising in line with the official figures for his area, in a way that someone working in Birmingham, England cannot because we only get a couple of different national disembodied averages for our official figures. So if the US figures are out of proportion with what workers are finding in the American cities the figures can be challenged in a way they cannot be in the UK.

Although the monthly figures can vary quite a bit across the US, in the longer run their system keeps them in line. On the basis of the index running since the early 1980s, price rises for Chicago have been less than for the US as a whole.  But only by a couple of per cent over what is now a whole generation (USA average currently at 221 and Chicago at 216). Prices for the workers have risen less than for the broader population – 218 for the US and 210 for Chicago workers, despite the current monthly figure being higher.

France also has an index that is intended to represent the total population as well as one that represents what is called an urban household  headed by a worker. It is particularly used for adjusting the minimum wage. For France  inflation was   1.7 %  for the main population in February and 1.6 % for the worker’s household. Until the 1960s France used to only calculate an inflation rate for Paris and say that that was the French inflation rate. But they continued to maintain a Paris index until about the time the Euro was launched.

The French have been able to keep inflation for these worker households in step with that of the overall population. Below you will see the figures showing how prices have shifted in the first years of the Euro before any of the dramas of recent years intrude into the story. In the table below 100 = 1998.

The figures are very much in step, as were the US figures because a more sensitive approach to tackling inflation tends to follow from such detailed indexing.

The Italian indices for registering inflation are today pretty much identical to the French system. In February the inflation rate for the broadest population was  2.4 %, and 2.3 % for workers’ families. Unfortunately the Italians no longer translate their full monthly release. It can be deciphered with only a basic French/Italian at the link here.

Table 4 of the Italian monthly release gives inflation rates for most of Italy’s big cities. This is most probably because inflation indices were first started by the big industrial cities like Milan, and led by Milan. It was Mussolini who brought in the national index, almost certainly because it would justify lower pay settlements for workers in the industrial cities than the local city inflation rate would justify.

So a basic local figure has since acted as a double check on the system – as it does in the USA. Milan is Birmingham’s twin city and inflation there is slightly less than the Italian national norm being currently registered as  2.3  %.

German inflation for February is 2.1%. Germany now only does one figure for the broad population of Germany. But most of the large federal states have produced a figure for their own local population since the 1960s. The State of Hesse, which is home to Birmingham’s twin city of Frankfurt, has an inflation rate which is slightly lower at 1.8%. We also have a twin city in the former East Germany which is Leipzig in the state of Saxony. The Saxon inflation rate is currently higher at 2.2%

However, Germans have lost trust in German price statistics since Germany went into the Euro in 1999. This is because the German government abandoned its more extensive range of monthly inflation indices. Former West Germany had produced price indices based on four household types across Germany. They were as follows:

The old West Germany ran such sub-headings since the 1960s when the managerial household was added to complete this set. When the West took over East Germany in 1990 they began to run a parallel set of sub-indices for there. By 1999 when these sub-indices were abolished along with the D-Mark, they were holding the inflation rates for all these households remarkably in step in both the former East and West Germany. Based on 1995 being 100, the family households in both East and West were at 105 on the index, and the ‘All household’ indices and the pensioner households were on 106.

Germany abandoned these baskets when they entered the Euro. They said this was because there were not enough four-member families to justify it. But had they assembled a more contemporary basket for families they might have maintained the confidence that there had been in the old system.

From what has been shown here of how other G7 countries register inflation, you will be able to appreciate the basis of what we are proposing should become our framework of inflation indices.

Our report for last month, which outlined how the global price spiral had to become the focus of our domestic economic policy, can be found here.

Andrew Lydon

Regional Prosperity & Inflation Project

Alternative inflation report – coping with an inflationary global economy

For the last couple of years we have been posting our alternative inflation reports just after the inflation figures for the main G7 economies have come out.  However, for over six months a pattern has emerged: the UK now has significantly higher inflation than any of them. So this month we will use this report to flag up some issues for readers to have in mind next Tuesday when the figures on the latest installment in our national inflation fiasco are announced.

The rise in food and energy prices has been seen by all sides as having  ignited the political explosion that has rocked north Africa over the past month or so. However, it is worth recalling that the official recent inflation figure for Tunisia was only 4% and in Egypt it was only about 10 %, which is about half the rate it was a year earlier.

Price Explosions

These inflation rates seem minor by comparison to the 1970s when no such explosions occured. One must conclude that it is the background of slow income growth, and the fact that the prices rises have been continuous –  that is making this crisis so intense.

The Bank of England always talks of keeping on top of people’s expectations, and preventing an inflationary spiral from taking off.  However, this current spiral in food and resource prices is international, and it is this international spiral that has taken off.  So has not now the time come to re-think our policies ?  So as to gear-up the UK for riding out this storm and the others that will come along.

While it is international resource prices that are driving this spiral, prices originating domestically must fall back otherwise inflation will be higher than it need be. Things like housing costs will have to fall if we are to pay higher prices for food and energy. This can already be seen in the United States but is not yet happening here. In December inflation for US urban consumers was 1.5 %.  If you look in the set  of figures released with that December US figure you will see that with what the Americans call ‘shelter’ taken out of the index, the US inflation figure would have been 2.0% For Chicago, without shelter inflation would have been 1.7 % instead of just 1.2 %.

Housing costs falling ?

So the falling price of houses and their rental prices is holding US inflation down. For most of the post-war period,  US house prices have been on average 3 times Gross Household Income.  When they reached 4 times average incomes  in 2006,  the US inflation index brought that little housing boom to a sudden end. And prices are currently under 3 times income.

Germany is the other major country that has a history of  being tough on inflation.   A big part of their success also lies in holding domestic accommodation prices down. Germany has held house prices stable for decades. Against a background of steady income growth this has made home ownership increasingly affordable for more people over the last couple of decades. While in relationship to incomes house prices in Germany are not dissimilar to UK prices, that is a steady improvement in a country that had to build so much of its housing stock after 1945. Home ownership affordability is improving most in the small towns and rural areas unlike over here. Homes in big cities are still too expensive for many to buy.

The main reason why the Germans and US have been more effective than us in holding housing costs down is that their inflation indices are very sensitive to housing. They are a big part of the notional baskets on which inflation is calculated. Almost a quarter of the US basket represents the value of owner-occupied housing alone.  20% of the German Consumer Prices Index is based on housing. By contrast, in the UK no more than 10 % of the Retail Prices Index (RPI) represents the basic accomodation costs. And the RPI claims to include housing in a way that the Consumer Prices Index does not !  For the last year rents were just under 7 % of the index. But another 3 % covers Mortgage Interest Payments. (Despite these payments being more the result of bank base rate decisions than the housing market).

Flawed UK indices

Alcohol however, is 6 %  of the RPI index. See table 4.12  in the document here. There is something seriously wrong with how we have weighted the UK inflation indices.   In 2009 Alcohol was 6.3 % and Rent was only  6.2 % !  And alcohol always had been bigger in the RPI. When it was originally set up in the 1940s, a professor at the London School of Economics wrote to the Times and asked rhetorically – what sort of family spends more money on alcohol than on clothes. ?

This problem with the weights is a major reason why many have considered that the UK indices have underestimated inflation here for decades. If there is too much alcohol in the index there must be too little of other things. We have got the weightings wrong.

Putting the indices right.

The Statistics Authority has now told the Office for National Statistics (ONS) that owner-occupied housing costs must now be factored into the Consumer Prices Index. The ONS are looking at 2 different ways of calculating it, called ‘ Net Acquisitions’ and ‘Rental Equivalence’ . In the chart below they show how each of these supposedly different calculations would have registered inflation during a period now universally seen as when we suffered the biggest house price bubble in our history (The blue line).  And the indices under consideration are shown in green and purple in this complicated chart below.

This chart comes from a bigger paper that can be found here. It is evident that neither of these measures would have alerted us to the inflationary problem except for right at the end of the boom when the  original CPI index was indicating a problem anyway. These calculations are therefore not fit for purpose, if that purpose is detecting and heading off inflationary problems. From what we have shown above, it will also be evident that the problem is that housing clearly does not have sufficient weight in the current indices and that the weights need to be revised. We think it is reasonable to expect that housing should have a weight in the index not very different from that seen in the German and American indices.

We will be making this point to the ONS. We will also suggest that the development of indices based on specific regions and localities of the UK, and specific household types, could help a process of revision of the weighting systems that would make the national figures more representative. We have earlier emphasized the importance of having regional figures if housing inflation is to be proportionately recognised – and promptly so. The ONS has been told to look into the issue of regional indices by the Statistics Authority.

When the BBC anounce the monthly inflation figures they usually say that the RPI includes housing costs to explain the difference from the CPI. From what we have shown above it can be seen that that is an over-simplification. In giving the figures a coherence they do not otherwise have, it borders on misrepresentation. Sky tends to just say the RPI is a wider index. However, last month the BBC did at last refrain from their usual practice of bringing on a banker to tell us that inflation is not as important as it might appear. (To justify low interest rates to savers). Last month the BBC even had the TUC on to comment on the figures.

The poor media coverage of inflation in recent years is also due to the sort of consultancies the media rely on. One of the most high profile is Capital Economics, founded and led by Roger Bootle who came from the old Midland Bank.  Bootle, always tends to minimise the prospects of inflation, which in the UK has been above the government target of 2 % for most of the last four years. What is almost never mentioned is that Bootle published a book called The Death of Inflation. Nowhere in the book does Bootle address the questions of how we detect inflation. Indeed, he published this book in 1996 just before UK house prices took off again under New Labour and became a serious form of British inflation that squeezed the middle of the British income spectrum, to borrow Ed Miliband’s term, and created the Two Income Trap to borrow an American term. Whether Bootle is responsible for the poor media attention to inflation or just reflects it must be left to history to judge.

Andrew Lydon

LWM Regional Prosperity & Inflation Project

Alternative inflation- the globalisation of inflation

Inflation across the Eurozone at 2.2 % is now above the European Central Bank target of   ‘2 % or less’.  In the big European economies it is now approaching 2 % with little hope that it is going fall back any time soon. The current figures for the big EU countries this report tends to follow are:

Germany         1.7 %

France            1.8 %

Italy               1.9 %

What has been becoming clear in the last few months is that other than in the USA and the UK, the current worldwide price inflation is now being seen as the problem to be addressed.

In the UK our inflation has been above our critical level of the 2 % target (plus 1 % ) for most of the last 4 years. The latest figures being 3.7 % on the least generous measure (Consumer Price Index) and 4.8 % on the more generous measure (Retail Prices Index). Figures  more than double the current US inflation figure of  1.5 %

A global problem now

And across the world, it is being recognised that this sort of inflation can only be addressed locally – economy by economy. The European Central Bank has now begun to react to the problem, but the leading Asian economies had already done so. China, India and now South Korea have recently introduced measures to contain the price rises.

Onions are the most recent food stuff of which India has banned the export. Such export bans have been a regular feature of the last couple of years. They are now  looking to lift their ban on the export of cotton to Pakistan, in exchange for Pakistan allowing onion exports to northern India. This sort of regional ‘bilateralism’ was what globalisation was supposed to stop.

Most of these price crises have been provoked by floods, droughts and other events stemming from  ecological/population dynamics. It is what we at LWM have called the Global Price Shift.  Even the floods in Queensland Australia seem to have driven up the price of coal and steel in Asia.

An explosive problem

The price shift is now also making itself felt in world politics with the current revolts in Tunisia and Algeria sparked by their government’s failure to hold down food prices. The fuel price rise in Pakistan has led to the Zardari government losing its majority.

Just what level of inflation becomes politically explosive depends upon how stretched the household finances already were in particular economies during the recent global boom. However, it seems that price rises more modest that those of past decades produce a more significant response than they used to. And there is no reason to think that this will not hold good in the more advanced countries too. There is also no reason to assume that this inflation is just going to fizzle out any time soon.

Driven by ‘globalisation’

That the price shift is under-appreciated in the Anglo-Saxon countries may have something to do with them trying to forget their old prophet – Alan Greenspan. He was warning that something like this was coming in his memoirs of 2007.

In the final chapter he outlines how in the globalisation that mainly occured while he led the US central bank, bringing China into world markets had made manufactured goods so cheap that it had squeezed inflation dramatically. He predicted that this was now coming to an end, and even suggested that globalisation would now begin to drive up prices for goods, food and energy around the world. At the time many central banks, including the Bank of England also echoed this warning. This is now turning out to be one of the few Greenspan prophesies to come to fruition.

This would make globalisation just too expensive.  And it going into a kind of reverse becomes the cheaper option, as can be seen when so many countries resort to  banning exports.

The solution begins at home

In the UK the main reason inflation has stayed so high, is that the problems were not properly recognised when they were emerging some years ago. And one of the main reasons for this has been that we have had such poor quality inflation indices. We reported last month how the UK Statistics Authority has ordered our ONS statisticians to address some long overdue improvements. The Authority has told them to go into the issue of regionalised inflation indices along the lines used in most other major economies and which we have been lobbying for since 2006.

Scotland merits having an index of its own. But in the interests of  getting things moving we would suggest that some indices based on ‘ad-hoc’ super-regions  would be a good start for England. Just 3 indices for England would be such a starting point, with the regions being grouped something like as shown here for inflation  purposes. But which regions were initially grouped together would need to be the subject of consultation with interests in the regions.

We have begun paying particular attention to the media coverage of the inflation problem. The public BBC has a particularly influencial role and have had particular attention. The main evening news programmes did feature comment from the leader of the TUC. This is unusual and welcome, as too much of the BBC coverage in the past has been dominated by bankers seeking to justify continued low interest rates. Hopefully the quality of the coverage of the inflation problem is improving.

To be covered in future reports

In coming months, our monthly reports will include spotlights being shone on how the cost of owner-occupied housing should be included in a proper inflation index as well as highlighting the unusual role of alcohol in the UK inflation indices.

With this month’s inflation figures we are seeing the Bank of England coming under attack for how badly counter-inflation policy is going. Our critique of the monetary policy system can be found in our  November  report.

Andrew Lydon

LWM Regional Prosperity & Inflation Project


Alternative Inflation Report – Bank of England failure ?

The highest rate of inflation among the original G7 members, is currently our UK inflation rate. Although there is much doubt about how representative the official UK figure is, no one really believes the official figure over estimates inflation. The October figures can be found at the foot of this report.

Over a decade after inflation and interest rate management was taken out of the hands of politicians this is an unexpected predicament. The whole logic of the hope of the 1990s was that the UK would have a sounder monetary system if politicians and their short-term agendas were taken out of this level of economic management. That was supposedly the lesson of experience overseas.

In 2010, one now has to ask whether price stability would have been better served, had it been something for which Gordon Brown, Alistair Darling, George Osborne or David Cameron had still been answerable every week at Question Time. This would have been a question that would have been asked for some years now, had not the entire political class rallied behind the Monetary Policy Committee system that New Labour used to claim was its most important reform.

UK inflation has now been above its target for most of the last 4 years. By contrast none of the other G7 has above target inflation. The standard G7 target is 2 % or less. An inflation rate of zero would be seen as the ideal. But here the UK is the odd man out. Our central bank would have to explain itself if the inflation rate was less than 1 %. Such a rate would be treated as as form of deflation, something to be averted here in the UK, unlike in other countries. Other countries trust their inflation indices and if inflation is reported as being about zero, that would not be regarded as a potential economic crisis but as an achievement.

The UK inflation indices are being reviewed by the UK Statistics Authority and we have been making representations to them about how our inflation indices can be more securely based. Details of the lessons from other countries can be found in our September report.

 

Should global inflation not fall back as the Bank of England hopes, the UK would be further blighted by already having the highest inflation. In our previous reports we have emphasized how global food, energy and resource prices are being driven up by ecological and population pressures. Being geared to respond to this sort of inflation will become the main challenge of economic policy across the planet.

However, the recent concern over ‘Currency Wars’ needs to alert us to another aspect of the global price shift that none of the mainstream economic commentators have picked up on. The US wants the Chinese to allow the Yuan to rise against the Dollar and other major currencies, so that Chinese made goods are not under-priced in comparison to other producers (and especially the US). However, this must necessarily mean that the price of the goods China manufactures will then rise alongside food and resource prices. Against this background, the Bank of England’s confidence that inflation is temporary, even if an increasingly long ‘temporary’, seems very complacent.

One of the major reasons why the Bank has got away with such complacency, is the very poor scrutiny they come under from the mainstream media. Most months the announcement of the official inflation figure is accompanied in many media by an economist from the banking sector telling us that inflation is not the real worry, and that interest rates need to be kept down. At the moment the profits and bonuses in the banks are largely the result of them being able to borrow off the public at the historic low interest rates and lend out at much higher rates.

This usually goes unquestioned  by the media, adding to the confusion over inflation in this country and the negligence with which it is addressed. It is at its most objectionable when the BBC allows the bankers to spread this confusion through a media service paid for by taxpayers. For November’s announcement  BBC 24 had on the economist from the investment bank Investec, last month it was his counterpart from HSBC.

The BBC tends to say that the difference between the Consumer Price Index (CPI) rate of inflation and the Retail Price Index (RPI) rate of inflation is that housing costs are included in the RPI. But this is an over-simplification bordering on misrepresentation.  There are housing costs in both indices. When we look back on the biggest house price bubble in British economic history over the last decade, no one can argue that even the RPI  registered the cost of housing in such a way as to prompt the adjustment of interest rates to curb it.

By contrast in the USA,  once house prices reached 4 times average houshold income in 2005, this cost had such weight in  the US Consumer Price indices that it raised the inflation figure. This raised the alarm with the central bank that prompted the interest rate increase that brought their relatively minor house price boom to an end. House prices fell back to below their long term trend of  3 times household income.

That American Consumer Price Index is an index that can be properly said to take housing costs into account. The current high level of our RPI inflation has nothing to do with the fact that our UK houses are still over 4 times average household income. While the RPI might talk the talk about taking housing costs into account, it does not walk the walk  in the way that  the US  consumer price indices do.

Stephanie Flanders, the BBC’s economics editor is listed as a member of the ONS’ s advisory committe on the inflation indices. ( Their current report can be found here. )  This advisory committee has resisted change to these poorly constructed indices since before the 1990s.  They are now proposing the most minimal of changes to the current indexing system while supposedly accepting that housing costs must be better represented in the index. This graph is from Annex A of their report.

It shows how neither of their preferred options for change regarding housing ( Net Aquistions and Rental Equivalence) would have changed the inflation figures during the ‘boom’ by very much and so would not serve as any alarm in future. Their new figures would not be significantly different, whatever the advisory committee say.

In any event, properly involving housing costs in the indices is only part of what we want to see. Regionalising the indices is even more crucial as we explained in last month’s report.

October’s comparable inflation figures are currently

United Kingdom               3.2 %

Canada                          2.4  %

Italy                              1.7  %

France                           1.6 %

Germany                         1.3 %

USA                                1.2  %

Japan                              0.2 %

Andrew Lydon

Regional Prosperity & Inflation Project


Alternative inflation report – why regional inflation alerts matter

The UK inflation indices remain largely unchanged this month, there being a similar increase to last month, and they remain higher than those on any of our G7 competitors. This is a trend now well set in – but largely unmentioned in the UK media.

The BBC 24 coverage of the inflation figures this month was only untypical in giving it a bit more time than other media. Besides over-simplifying the differences between the Consumer Prices Index and the Retail Prices Index, they brought on a banker to tell us that the inflation registered was not really important and that we need to keep interest rates at their record lows and may need to print more money. This is the usual banker position on inflation.  The low interest rates (paid to savers) and the printed money are the only things that have brought them back into profit, even while few other businesses are. The BBC’s own experts never challenge them on this.  This month the banker pushing their cause was HSBC economist, Bronwyn Curtis.

The main inflation figures for the G7 can be found at the foot of this report.

At the end of the 1990s Digby Jones, the Confederation of British Industries (CBI) West Midlands regional chairman, became the only such regional chieftain to ever become the national CBI leader. West Midland’s manufacturing was on the ropes during the very first years of the New Labour government, with the newly independent Bank of England. The Pound, according to DJ, was overvalued because the Bank of England’s interest rate committee was keeping interest rates high in order to surpress house price inflation in London and the south.  DJ was implying that inflation generated in the south was being taken on by the bank at the expense of manufacturing further north.

In our July report we outlined how we thought real inflation had had a dramatic effect in the UK in the New Labour years. We pointed to how it now takes two incomes to run a household that could be run on one income a generation ago. We borrowed the term the ‘Two Income Trap’ used in the US by the Harvard academic and congressional advisor Elizabeth Warren.

In the UK we asserted that this had come about because of the average price of housing doubling in terms of incomes under new Labour. This can be seen in how before the crisis of 2008 those average homes cost  between 6 and 7 times  average incomes, when they had been about  3 times income when New Labour came to power. This sort of inflation had not been addressed because, unlike in many other countries, it is not reflected in our inflation indices.

In our July report we pointed out how in the West Midlands this two income trap had been emerging earlier during what has been  called the ‘Lawson boom’. This  occured in the last years of Margaret Thatcher’s government and peaked when the UK had to withdraw from the European Exchange Rate system in 1992. Nigel Lawson her Chancellor lost control of inflation in those years. He had been secretly adjusting interest rates in order to keep the Pound in line with the Deutsch Mark. It was later referred to as ‘shadowing the Deutsch Mark’. This was a policy that led him to disaster – during which people in the West Midlands got a taste of what the Two Income Trap held in store.  They have since associated this with the Tories, even though real housing costs fell back here under John Major and Ken Clarke.

In his memoirs Lawson recounts how he had lost faith in the deeply flawed Retail Prices Index. This was the context in which he started to shadow the Mark. He was effectively relying on the German system to detect inflation and following their lead. Hence he was reacting to international prices rather than to our national prices. Lawson never thought of reforming the UK inflation indices. Had he begun to learn from most of the other G7 countries he would have been thinking of regional inflation indices and indices based on different parts of the social spectrum such has key workers and pensioners. Our last report detailed the most instructive lessons from the rest of the G7.

Had Lawson even had an experimental index for even one of the regions or nations of the UK, he would have served the interests of our UK economies better than any shadowing of the D-Mark could have done. Had that region been the West Midlands or a wider midlands area it would have most clearly alerted him to the Lawson boom being out of control. It could then have been reined in before  it both led to the crises that squeezed our manufacturing industries so badly in the early 1990s, and blighted his party in the midlands.

Had Gordon Brown as chancellor had regional indices, a West Midlands index that included the sort of weight for housing that one finds in other countries, it would have alerted him to the underlying inflationary dynamic in the UK economy. This is clear in the cost of housing in relation to incomes in the West Midlands. Despite the fact that our manufacturing employment was in the serious decline that Digby Jones highlighted, house prices in income multiples in the WM stayed closer to the London figure than the national average of  5.86.

An inflation index for the West Midlands that gave appropriate weight to this, as they have in the localities of Germany and the USA, would have served to show there was a problem emerging. Even if that emergence was only yet clear in the West Midlands. The middle was being ‘squeezed’ – as Ed Miliband might say.

For the last couple of decades politicians of all parties took more interest in looking after the economic comfort of the ‘wealth creators’.  However, with the recent General Election, this may have changed. The bankers are now denounced right across the political spectrum and the parties are fighting for the support of the middle that is squeezed. The UK Statistics Authority is curently having a review of the current UK inflation indices. We have pressed them to clear the way for the establishment of indices that will allow the politicians to get their fingers on the pulse of the price shifts as they affect key parts of the social spectrum. For our part of the UK we thought the following set of sub-indices would serve.

We hope to hear within the month about how the Statistics Authority see the inflation indices being developed.

Andrew Lydon

Regional Prosperity & Inflation Project

The comparable inflation figures when this report was written were

United Kingdom            3.1 %

Canada                          1.7  %

France                          1.6 %

Italy                               1.6  %

Germany                          1.3 %

USA                                1.1  %

Japan                            -0.9 %

Alternative inflation report – how other countries are doing it better

Our last couple of reports have focussed on the unexpected wave of inflation that is being felt around the world despite us supposedly being involved in a global downturn, and how the UK is particularly feeling it.

This month we are focussing on how other major G7 countries measure inflation as it impacts upon different parts of their countries and social structure. Something we want to see done here in the UK and are currently pressing the Statistics Authority for.

The USA gives out the most comprehensive set of inflation figures every month. This month the CPI-U, representing the broad urban population is  1.1 % .  But it also gives a CPI-W figure for ‘urban wage earners and clerical workers’ which this month is  1.4  %. But they don’t just give a national figure for each of these populations. They also give a CPI-U figure and a CPI-W figure for most of their big cities and the US census regions.

This has made the USA very sensitive to emerging inflation and has prompted the USA to be one of the world’s lowest inflation economies.  A worker in Chicago and the Mid-West knows whether his prices are rising in line with the official figures for his area, in a way that someone working in Birmingham England cannot because we only get a couple of different national disembodied averages for our official figures. So if the figures are out of proportion with what workers are finding in the American cities the figures can be challenged in a way they cannot be in the UK.

Although the monthly figures can vary quite a bit across the US, in the longer run their system keeps them in line. On the basis of the index running since the early 1980s, price rises for Chicago have risen less than for the US as a whole.  But only by a couple of per cent over what is now a whole generation. (USA average currently at 218 and Chicago at 213)  Prices for the workers have risen less than for the broader population – 214 for the US and 206 for Chicago workers, despite the current monthly figure being higher.

France also has an index that is intended to represent the total population aswell as  one that represents what is called an urban household  headed by a worker. It is particularly used for adjusting the minimum wage.  For August inflation was 1.4 % on both indices. Until the 1960s France used to only calculate an inflation rate for Paris and say that that was the French inflation rate. But they continued to maintain a Paris index until about the time the Euro was launched.

The French have been able to keep inflation for these worker households in step with that of the overall population. Below you will see the figures showing how prices have shifted in the first years of the Euro before any of the dramas of recent years intrude into the story.  In the table below 100 = 1998.

The figures are very much in step, as were the US figures because a more sensitive approach to tackling inflation tends to  follow from such detailed indexing.

The Italian indices for registering inflation are today pretty much identical to the French system. In August the inflation rate for the broadest population was 1.6 %, as it was for workers’ families. Unfortunately the Italians no longer translate their full monthly release.  It can be deciphered with only a basic French/Italian at the link here.

Table 4. of the Italian monthly release gives inflation rates for most of Italy’s big cities. This is most probably because  inflation indices were first started by the big industrial cities like Milan, and led by Milan. It was Mussolini who brought in the national index, almost certainly because it would justify lower pay settlements for workers in the industrial cities than the local city inflation rate would justify.

So a basic local figure does since act as a double check on the system – as it does in the USA.  Milan is Birmingham’s twin city and inflation there is slightly less than the Italian national norm being currently registered as 1.4 %.

German inflation for September is 1.0 %. Germany now only does one figure for the broad population of Germany. But most of the large federal states produce a figure for their own local population since the 1960s.  The State of Hesse, which is home to Birmingham’s twin city of Frankfurt has an inflation rate which is slightly lower at 0.7 %. We also have a twin city in the former East Germany which is Leipzig in the state of Saxony. The Saxon inflation rate is currently higher at 1.1 %

However, Germans have lost trust in German price statistics since Germany went into the Euro in 1999. This is because the German government abandoned its more extensive range of monthly inflation indices. Former West Germany had produced price indices based on 4 household types across Germany. They were as follows

The old West Germany ran such sub-headings since the 1960s when the managerial household was added to complete this set. When the West  took over East Germany in 1990 they began to run a parallel set of sub-indices for there. By 1999 when these sub-indices were abolished along with the D-Mark, they were holding the inflation rates for all these households remarkably in step in both the former East and West Germany. Based on 1995 being 100, the family households in both East and West were at 105 on the index, and the ‘All household’ indices and the pensioner households were on 106.

Germany abandoned these baskets when they entered the Euro. They said this was because there were not enough 4 member families to justify it. But had they assembled a more contemporary basket for families they might have maintained  the confidence that there had been in the old system.

From what has been shown here of how other G7 countries register inflation, you will be able to appreciate the basis of what we are proposing to the Statistical Authorities should become our framework of inflation indices.

Our last monthly report can be found here.  This month the UK figures have not fallen like most of the G7 figures have, as can be seen in the list below. The UK remains the country with the highest rate in this group, and has long been in this position.

Andrew Lydon

Regional Prosperity & Inflation Project

This month’s comparable inflation figures are currently

United Kingdom                3.1 %

Canada                           1.8  %

France                           1.7  %

Italy                               1.6  %

USA                                1.1  %

Germany                         1.0 %

Japan                            -0.9 %

Alternative inflation report – or what Mervyn King does not mention

Our Retail Prices Index (RPI) stands at 4.8 % and the index the Bank of England targets – called the Consumer Price Index stands at 3.1 %. They are higher than the targeted indices of any of our G7 competitors.  Almost double the next one down the list.

France                 1.7  %

Germany            1.2 %

USA                      1.2

Italy                     1. 0 %

Canada                 1.0%     (June  figure)

Japan                 -0.7 %    ( June  figure)

This report was originally just intended to keep the fact that this country has usually got the highest inflation figure in the G7, despite us having inflation indices that understate inflation, in the minds of various people we are lobbying.  But we now use it to outline how our ideas about inflation are developing. As such we hope it is more interesting than the Bank of England’s quarterly Inflation Report, which concentrates on optimistic predictions that are almost always wrong in recent years.

We have consistently warned that food and energy prices are straining living standards across the world. Of course food is of far less weight than in the inflation baskets of the developed world than it was in the past , or than it is the developing world. It averages about 40% in some of the most populous Islamic countries, like Pakistan and Egypt for example, where social instability could have global consequences.

So although the fires and floods that are becoming a regular summer occurrence on the Europe-Asia landmass put pressure on our standard of living, it is many times more serious elsewhere.   

For example, Russia has again banned wheat exports which is already driving prices up outside that country. Stopping  farmers exporting is one of the world’s traditional ways of holding down prices in producer countries’ home markets.

Rather than inflation in the UK being the result of a series of one-off occurances as Mervyn King insists,  perhaps we are heading for a new world-wide era of Austerity. With inflation rather than deflation being the main global issue. What we have been promoting as our Regional Prosperity and Inflation Framework, might well have to serve as an ‘Austerity & Inflation’ Framework.

We have also recently published our outline of what an inflation index for our home region would actually tell us.

Using the most authoritative housing affordability figures for the regions – produced by the Halifax – we can see how housing prices, which should have weight in any proper inflation indices, demonstrate how a clear ‘Two Income Trap’ emerged under New Labour. It seems it now takes 2 incomes to buy a home that could be bought on one income when New Labour came to power. This fits with our long standing argument that two incomes are now required to run a household that could be run on one income a generation ago. But interestingly, the movement in house prices occurred as early as the Lawson boom of the late 1980s as far as the West Midlands is concerned. But real house prices fell back under John Major, before becoming the national phenomenon since. This is explained further on this project’s main webpage and it can also be accessed here.

This erosion in real wages did not help manufacturing jobs survive in the West Midlands, even in the later years of the Thatcher government. Had Nigel Lawson had an authoritative index for inflation in regions like ours, perhaps he would have heeded the warning it would have been sounding – and have restrained his inflationary boom before it became a national disaster. Labour would not then have slid down the same slipway. But that would have been a very different Britain, which might today have more manufacturing and less household debt than it has actually come to have.

We have recently set out a path for reform to the Statistics Authority’s review of inflation, and we are grateful to the Trust that has regularly supported us in this area of work  in recent years – The Andrew Wainwright Reform Trust.

Our report last month challenged the notion that we have been struggling with a global deflation in any way comparable to the 1930s and can be found here.

Andrew Lydon

LWM Regional Prosperity & Inflation Project


A trend set in – Alternative inflation report for June

Our Retail Prices Index (RPI) stands at 5 % and the index the Bank of England targets – called the Consumer Price Index stands at 3.2 %. They are higher than the targeted indices of any of our G7 competitors.

France                 1.5  %

Italy                     1. 3 %

Canada                1.4  %   ( May  figure)

USA                      1.1  %

Germany            0.9 %

Japan                 -0.9 %    ( May  figure)

It looks like a trend has now firmly set in for us to be the G7  inflationary economy. Besides undermining our living standards this will help overseas companies keep their grip on our home markets. In the post war decades, we could always rely on the Italians and often the French to have higher inflation than us.

Much has been said about how various world leaders have saved us from a repeat of the 1930s. But no repeat of the 1930s deflation has ever been on the cards in the last few years.  The price of food and energy had fallen after the First World War and had no tendency towards rising until the rearmament began in the late 1930s. This can be seen in the graph below of the UK cost of living index, the vast majority of which was food and energy purchases.

By contrast there has been an under-lying upwards push on food and energy prices through out most of the last couple of crisis years. Recently we have seen demonstrations against  the price increases across India and as drought grips important grain producing regions around Russia  the upwards pressure on food prices is set to continue.

Commentators have been talking about how close we have been to deflation. But  in the UK particularly, this is indicative of the poor standard of economics in this country. Briefings from the Bank of England in particular, often seem to suggest that  inflation does not just mean that prices are rising. They imply that inflation only becomes something when wage claims begin to be put forward on the assumption that prices will go on rising.

We have recently set out how we think inflation and especially house prices have undermined the standard of living in our West Midlands home region which you can go to by clicking here.

Last month’s edition of this report included an examination of how the UK lost track of its own people’s living standards in the 1980s,  and how conservatives are still politically blighted by it.  It can be accessed here

Andrew Lydon

LWM        Regional Prosperity & Inflation Project

Lessons from the Thatcher/Reagan years – an Alternative inflation report

The new coalition government have inherited the highest inflation rate in the G7. Higher even than China. And as they consider any sort of increase in VAT to pay off national debt they need to think about how they keep their finger on the national pulse as the country faces these challenges to their living standards.

Immediately on coming to power, Margaret Thatcher’s chancellor raised VAT, much against her initial reluctance. And this was the start of a process that lead to the popular perception that living standards had been badly hit under Margaret Thatcher. And for no lasting gain.

This chart shows the official story of living standards in the UK. We are supposed to be about twice as prosperous as we were in the 1970s.

The hard times under Thatcher and Major are merely slight setbacks that we quickly recovered from. But if people really bought that story, why did the Tories, even with the mess that Gordon Brown made of our economy, face such reluctance to allow them an overall majority in 2010? Birmingham and the West Midlands are a striking example of this reluctance.

Contrast this blight on the Tories to what happened in the US under Ronald Reagan whose heirs have never been blighted by Reaganism. Two George Bushes stand as evidence of this.

This chart shows that Reagan’s legacy was because living standards in the US were hit more under Nixon and Carter, and actually stabilised under Reagan. This chart and this outcome were in large part because they had good quality inflation and prosperity indicators.

When Reagan came to power, the US had long had monthly inflation figures for most big cities and even had regional indices. However, in the first years of Reagan they improved their inflation indices by revising the way housing was measured. This allowed them to apply counter-inflationary policies while having their finger on the pulse of the people’s economic life.

On behalf of LWM I am currently pressing the UK Statistics Authority to look at what can be learned from the system of US inflation indices.

History often seems to repeat itself, first time as tragedy, second time as farce. A government presiding over austerity that looses track of prices as they are felt across the country, would be a farce none of us would want to see. The coalition needs to allow the best inflation indices to be put in place and allow it the priority it deserves.

Andrew Lydon

Regional Prosperity & Inflation Project