Seldom does another topic supplant the weather as the most common conversation topic amongst Brits. And yet, for six months now, temperature has been eclipsed by heated talk of sharply accelerating consumer price inflation. Now, when discussing today’s weather, there is very often the element of how climate change is affecting matters and what we can do to improve things. There is, however, no such consideration of how we can act to make cost matters cooler for ourselves than indicated by the rapidly rising CPI. The cost of living is, it seems, ‘out of our hands’. Well, for a whole host of reasons, it most definitely is not.
The cost of living is very much collectively ‘in our hands’, not least because we can improve our energy security and by doing so make energy more affordable. This heated topic was covered recently in the missive ‘Finding the energy to secure our energy future. In this short piece I turn to how, in the individual ways we shop around for the most competitive alternative, we can collectively fare financially better than the official numbers warn.
“I will, in short, claim that the much vaulted CPI exaggerates – yes, overplays – how much we are paying because it underplays how quick we are at adapting our spending”
In what follows, I will, in short, claim that the much vaulted CPI exaggerates – yes, overplays – how much we are paying because it underplays how quick we are at adapting our spending. Adapting, not because we are trading-down for inferior goods and services, but because we are quickly exploiting the array of alternatives out there for our valued custom.
Imagine we were given a single figure for today’s likely temperature across the UK; there would be uproar and demands for detail. And yet, we accept the CPI as being a one-size-fits-all measure. A proper critique of CPI would be exhausting, so I will confine myself to just one element. Specifically, why it is not the inviolately accurate measure of how our cost of living is changing, and why it is particularly poor when prices appear to be rising dramatically. Those with a microeconomic textbook to hand will know that what follows is a simplified attempt at bringing to life Slutsky and Hicksian elasticity of substitution effects.
The simple truth is that the weights used to basket together what makes-up our spending lag our behaviours because they assume our spending on particular items is inelastic to its relative price with alternatives. And because none can doubt that lockdown resulted in major behaviour change – some of which has stuck and played havoc with all economic measurement – none can challenge the idea that the CPI is measuring us as we were, not as we are. We have, in short, been substituting what we buy at a speed like never before.
For instance, I can say with confidence that the CPI exaggerates how impactful changes in petrol prices are on our budgets. The reason is that the CPI is not adjusted fast enough to how we are driven more in Ubers, ride more on bikes, and generally use our own cars less, and in particularly use fewer petrol driven vehicles. Britons have also taken to home delivery of all sort of things, more than any other nation; this another instance of where we are less impacted by the cost of filling our tanks. And this trend, evident for all to see but not accurately measured within the CPI, has been supercharged by the recent spike in petrol prices.
Consider next our food costs. Here too the CPI exaggerates matters. Whilst I accept there has also been ‘shrinkflation’, I still contend the CPI exaggerates the food inflation ‘we choose’ to face. The CPI has been slow to adjust to our behavioural change towards home-delivery of restaurant quality food – whose price inflation has been less than recorded in supermarket food pricing. The CPI has also been slow to take-in the rise of disruptors within the grocery market – from the likes of Lidl and Aldi, across to the home deliverers of ‘all the fresh ingredients’ you need to make a meal. Remember these platforms want to grow their respective market shares to increase their net margins. Consequently, and very sensibly, they have ‘held back’ on price increases so as to win the custom they need for operational optimality. And yet, I will say again, this competitive pricing is not picked up in the CPI. Would this make any difference to the CPI inflation we are seeing? Well, it and all the other ways the CPI exaggerates matters meaningfully add-up.
The degree to which we heat our homes is also discretionary in a way the CPI fails to capture, and so exaggerates increases to our cost of living. I could go on and on itemising elements of the CPI whose sudden increase in price has resulted in our perfectly practical substitution, abstinence, and other forms of amelioration. Do not get me wrong, I anticipate that once the dust has settled and a proper measurement is made of it, the UK’s average rate of consumer price inflation will be closer to 4% than 2%. We need to accept this and ask the MPC to manage monetary policy within a revised range of 2%-4%. And within the CPI basket I expect the cost of the ‘staff’ we use will drive inflation more than the ‘stuff’ we buy. Here too we have a rather enigmatic element of the CPI. Because a growing share of the CPI captures the personal services we buy, it actually picks up wage inflation. Our visits to hair and nail salons, theatres, sports arenas, and hotels where we actually consume ‘experiences’ will become all the more expensive and as such will contribute to keeping the CPI elevated. And as much as some of this will be driven by energy and other non-labour costs, an increasing share will be because the staff who serve us, as we eat-out for instance, are earning all the more. So whilst a new-elevated normal rate of CPI would prima facie seem to be eating in-to household budgets, it will in fact be favourable to serving-staff on, as it were, the ‘receiving end’.
As such, those who subtract CPI from wage growth to gauge the pace of real wages are really missing how one’s consumer price is another’s wage and vice versa. We are, in short, iterating our incomes higher not in a vicious cycle, but virtuous one. Those who consider this fanciful arithmetical nonsense might like to reflect on the fact that, in not being adjusted as quickly as we have quickly adjusted our behaviours, the CPI almost certainly underplays in its weighting ‘staff’ over ‘stuff’.
To be clear, I am not denying our cost of living has increased or that it will not do so at a faster pace than we have been used to, and I am far from insensitive to how rising prices are hitting households. I am merely making the point that just as GDP inherently underestimates UK economic growth, so too CPI exaggerates inflation. The risk we face is that these two measurement biases risk policy errors; both monetary and fiscal.
We risk, for instance, the MPC lifting the base rate by more than is truly necessary. What would happen in this case is inflation slowing sharply because the real economy has been ‘handbraked’ when it needed a more gentle use of the foot brake. There is also the risk that the Chancellor tries to help mitigate with tax cuts and/or cash handouts for cost shocks which our altered behaviours have already partially ameliorated. What would happen in the case of not entirely deserved – but welcomed – ‘windfalls’ is that measured consumer price inflation would prove more persistent and broader, and the peak base rate higher for longer. Monetary conditions proving tighter, that is, than were proper consideration given within Downing and Threadneedle Streets to the sensible self-help being performed by households to part protect themselves from rising prices.
One only hopes the current crop of MPC members are as aware of these measurement failings as Professors Bean, King, Nickell, and earlier wise heads were, when deciding the base rate. And only hope the Chancellor – Mr Kwarteng or whoever else – has the same wisdom as the one we were fortunate enough to have had until quite recently.
