Inflation Figures: Indication Deviation

Everyone’s talking about inflation.

This week we heard George Osborne saying that there is no problem with low inflation.

But we also hear from eminent economists about the dangers of low and negative inflation.

So what is really going on?

Well inflation figures (primarily) indicate two things:

  • our spending power
  • the metabolism of the economy

Annoyingly, these two “good things” are inversely proportional. ie when inflation goes up, our spending power goes down but the economy is working harder. And when inflation goes down, we have more spare cash, but the economy is slowing down.

But recent events have revealed how the inflation figures that we use to indicate both things are misleading. (These are CPI and RPI.)

Oil prices falling affect the inflation figures as indicators of spending power. ie when oil prices go down, we have more spare cash.

We all buy a lot of oil and oil derived products. (Of the 100,000 plus products and services that are part of the inflation calculation (for CPI), petrol and diesel alone have a 3.5% weighting – ie one product, 3.5% of our expenditure.

But oil prices are less indicative of the metabolism of the UK economy. Subsequently a common statistic is used which is CPI excluding volatile prices like energy and food – this called “core inflation”.

However, most oil (and derivative products) come from outside the UK, so the change on oil price only has a partial effect on the UK economy.

For Russia, the falling price in oil is a massive problem as oil is core to Russia’s economy. So the deflation of oil prices will mean that Russia has less money coming in. This could lead to job cuts and profit margins falling – less money for everyone… in Russia.

Because the UK is so diverse, it is hard to think of a single industry that could have such a significant effect. Oh, hang on… maybe the financial sector?! But let’s not get misled as we are now talking specifically about the effects of a fall in income for the UK as a result in the fall in demand for a UK-produced product or service.

Anyhoo… my question is whether we should create a new inflation figure that reflects the health of the economy with a different weighting index to that of the “consumer spending power inflation” figures.

So perhaps, we should consider what we could call the “Impactive Inflation Rate” as well as a consumer inflation rate. The latter describing spending power, the former describing the effect on the economy.

This would be an inflation figure, based on a basket of goods, but with a weighting index that describes the effect on the UK economy. Items weightings would take into consideration factors such as the percentage of UK people employed in the business related the product or service.

Anyway, that’s my ha’porth!

For more well-qualified views on inflation here are some good picks from the last few days:

FT’s Gavyn Davies

Krugman

A Tutorial from Geoff Riley

Simon Wren-Lewis

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