Friday, 17 August 2012



Can both indices be right?

The retail price index (RPI) and the consumer price index (CPI), if correctly constructed to reflect 'the cost of living', and if the data is correctly gathered and correctly weighted, should both show the same rate of inflation, year by year. But they do not agree. The change in the CPI is consistently lower than the change in the RPI. In the last 24 years the RPI has grown 125%, the CPI only 100% [1]. The gap is not consistent, but the lines never cross over. So the Government, irrationally but understandably, pays out on the CPI and claws in on the RPI.

Though each index is constructed with great care and scrupulous openness, it would seem that the 'basket' of items for one index is 'better' than another, i.e. it more closely represents what people in Britain actually spend. If each index correctly represents what the average family spends, they should not differ; except that there is no average family. The CPI is based on the European Harmonized Index of Consumer Prices (1996). The RPI is much older with a data set running back to 1956. There is no mystery regarding the content and manipulation of the data; an enormous amount of information is published online (See references below). An excellent discussion of difference between to CPI and the RPI is given in reference [5].

There are 3 major issues. (1) The clearest (and apparently deliberate) difference between the two is that the newer CP index excludes all references to owner-occupier housing, (thus excluding: council tax, mortgage interest payments, house depreciation, buildings insurance, ground rent, solar PV feed in tariffs and house purchase cost such as estate agents' and conveyancing fees). (2) The next most striking feature is that the CPI employs 'geometric means' as well as simple averages, i.e. 'arithmetic means'. (The logarithm of the geometric mean of a series of numbers is the arithmetic mean of their logs. Thus the geometric mean of 10 and 1000 is antilog (1 + 3)/2 = antilog 2 = 100; while the arithmetic mean of 10 and 1000 is (10 + 1000)/2 = 505.  The geometric mean of a series of unequal numbers is always less than the arithmetic mean.) (3) Thirdly, RPI excludes very rich and very poor expenditure patterns which are however included in the CPI. It is also the case that the baskets are updated in slightly different ways; once a year for the RPI with a 1 month overlap between new and old basket, twice a year for the CPI.

I would suggest that, in-so-far-as people do in fact spend a lot of money on owner-occupied housing, the CPI is essentially invalid. The Office of National Statistics is working on the problem and believes it will have devised a new index by 2013. Regarding the use of geometric means I cannot see why the geometric mean is valid. Let us consider bread. Suppose a loaf can be bought for (£) 0.5, 1.0 and 1.5?  I think that neither geometric mean (0.91) nor arithmetic mean (1.0) is correct. I suspect there are more loaves sold of the cheaper sort, but that is nothing to do with the geometric mean. Surely the sum spent on bread is the product of the price and the number of units sold. The average cost of a loaf can be got by dividing the total cost by the number of units. Only by knowing the number of each type sold can you improve on the simple average. Regarding the inclusion of very rich and very poor in the CPI, I doubt it is a serious improvement. There may be a significant portion of the GDP spent on caviar and large yachts, but by an insignificant portion of the population. Properly weighted (per caput not per £UK), the rich and poor extremes should perhaps be included.

Regarding the updating of the baskets it is worth noting that the current value of each index is related only tenuously to a benchmark year. If the RPI basket in 2012 were identical to the 1956 basket we could indeed relate today's £UK to that of 1956. But the baskets change every year, so the RPI of today can be related only to that of January 2012, and that in turn to January 2011; and so on back to 1956. A systematic error could lead us astray. Even a summation of random errors would allow the Index to wander (like a drunken sailor or a diffusing molecule).

So, it is a complex subject. For the time being, I feel inclined to average the RPI and the CPI. Or simply use the price of a Mars Bar/bag of crisps/box of matches — which after all gives us an absolute benchmark and not a wandering chain.





[4] ONS (2010) ÔDifferences between the RPI and CPI Measures of InflationÕ

[5] ONS (2011) ÔImplications of the differences between the Consumer Prices Index and Retail Prices IndexÕ.




L. Cawstein

Friday, 10 August 2012

Deficit Spending 2

Deficit spending (2)

Let us rethink entrenched positions, and seek an intelligent and humane middle road.
My old school friend Howard is boldly, proudly, consistently, and cogently left of centre in his politics. Family background placed him there at an early age, but PPE at Oxford did not deflect him from the path of the 'honest citizen'. I, on the other hand, born and brought up as a Liberal and thus uncomfortably astraddle the fence all my life, have been struggling with the balance between labour and capital ever since I became politically aware with the advent of Thatcherism. "I still hate that woman" said Howard the other day. "Well, we wont fight over that", said I, "but she did curb the unbridled power of the unions that was holding the country to ransom".
Back in 1979 I spent many hours trying to work out which argument was correct; the Tories thought that 30 years of full employment had handed power without responsibility to the unions who were forcing up prices with irresponsible (leapfrogging) wage demands and thus pricing Britain out of world markets. I could see the truth of that. On the other hand, deliberately to contrive unemployment in order to break a strike seemed to me a dirty trick as it imposed real hardship on hundreds of thousands of innocent people who could surely have been won over by simple logic. I resolved my dilemma at that time by concluding that there was no single correct policy; both policies were correct; it depended simply on who you were. If you owned a factory it was 'right' to keep wages low. If you were a worker it made perfect sense to bargain collectively; the 'right to strike' seemed to be the country's only protection against slavery. That solved, I could return whole-heartedly to my professional work as a scientist.
However, in retirement, I can see that I had not resolved the dilemma, but simply ducked it. The country does in fact have to be steered down that delicate line. Our quaint "first-past-the-post" political system in Britain tends to flip-flop the country sloppily across the line every 7 to 11 years. (No doubt in response to, and in synchrony with, the business cycle; though I have not heard anyone say that.) Can we not do better than that? Should we concentrate on cutting the deficit to below zero, and start to pay down the National debt? Or do we attempt to re-stimulate the economy with further deficit spending. Is this just another political football which you boot to left or right on simple class principles? Does anybody understand the economy sufficiently, and in a sufficiently scientific and disinterested way, to persuade all political parties to a common economic policy?
The Conservative way out of a recession is to let rising unemployment weaken unions and lower wages till business can once again turn a profit. This attitude so angers the workers that they demand a Welfare State safety-net and, if pushed too far, the nationalization of the mean of production. Liberal opinion, in my eyes, epitomizes the best aspects of tolerant, caring, humanity (the sort of humanity that staged a sugar strike not for its own benefit but for that of the plantation slaves). Liberals should seek to understand the business cycle, and use that understanding to anticipate and minimize the boom years, and minimize unemployment and hardship in slump years. Not because enforced unemployment is bad for the economy, nor bad for their own 'class'; but because it is bad for people. As, of course, is the Welfare State.
Textbook Keynesian monetary theory points out that when Saving exceeds Investment (because business prospects are poor), money is lost from the system and a depression becomes a recession. Applied to the business cycle, it further suggests that the State should run a deficit when the private sector contracts, restoring its reserves during the preceding and subsequent boom years. Classical monetary theory replies that deficit spending hurts business more than it helps; it raises wages (or prevents their fall), and it raises interest rates.
Should liberals therefore side with Labour and demand deficit spending in the current (2012) recession? I am afraid I do not trust the depth of analysis of Labour's call for deficit spending. I fear that they are re-playing Keynes' own depression of the nineteen thirties. Consider:-
[a]  Britain did not build up reserves during the preceding boom years; it built up debt, (and ran down its gold reserves: ). A glance at the pie-chart of UK government spending shows that not defence, not education, and not even health is running away with the money; it is the welfare budget that dwarfs all the others [1]. We are little better than the Greeks. Currently we spend as much annually on servicing the national debt as on housing and the environment (4% of GDP). Woe if that should double!
[b]  Keynesian deficit spending is indeed damaging to business if there is insufficient slack in the labour market. And indeed, there is no great unemployment in the UK. The British public has shown every indication that it would buy more foreign goods if it had more money.
[c]  British household are not stashing spare money under the bed. The average British adult is harbouring a massive £30,000 debt! If the State wished to borrow money to deficit-spend, it would have to borrow off the Chinese on the money markets; not from its own citizens (as is the case in Japan).
[d]  Most commentators agree that some government spending on infrastructure would be beneficial in the long run. On carefully chosen projects it might also help in the short run, if the allocated wages lower welfare payments and raise tax revenues. Some highly experienced economists are beginning to murmur about possible Government spending [2], and a possible delay of the planned 'fiscal tightening' [3]. But my own assessment is that we do not have high unemployment, and the money markets currently seem surprisingly satisfied at the longer term stability of Sterling. So steady-as-she-goes seems the right course at present. Continue to build houses, roads, and railways; sponsor apprenticeships, tighten welfare payments, and collect taxes.

L. Cawstein

Wednesday, 8 August 2012

Debt 4

Debt (4)

"Non-productive lending by banks is beggaring the country."

It has been said that we shall never get out of the present quagmire of debt in which the Western democracies find themselves unless there is growth. And I guess that is true in a horrifyingly simple way.

If I were to borrow money to build a windmill it would be with the thought that the windmill would earn me 10% per year in flour. I could pay 5% to the capitalist and still my enterprise would be worthwhile. If I borrow money to buy a car, how on earth am I going to pay the money back, let alone pay 5% interest to the lender of the money? Except from another source, so borrowing off Peter to pay Paul.

According to Credit Action [1], personal debt in the UK in April 2012 stands at £1.459 trillion (of which mortgage-secured housing debt is £1.252 trillion). To grasp the magnitude of this, you should note that the gross domestic product (in 2009) was £1.396 trillion, while the assets of Barclays Bank plc (in 2011) was £1.459 trillion. On average each adult in the country is £30,000 in debt, largely for their house. Suppose they can pay the interest at 5% p.a., but cannot pay down the capital. Without what the politicians call 'growth' (and I call inflation) these citizens will spend their lives, like a herd of dairy cows, being milked by the bankers for the whole of their lives.

However, since the war, we have got used to a steady 'growth' of the economy. That is to say, the uncorrected data of the Office of National Statistics (a mixture of inflation and 'growth in real terms') shows a strong and persistent logarithmic 'growth' in GDP of some 9% p.a. Look at the data [2]; in the 50 years since 1958, the uncorrected GDP of the UK has grown 63-fold! If correction is made for inflation the growth is a mere 3.7 fold. In other words, the apparent growth of the economy (averaging over those 50 years) is 9% per annum, though GDP 'in real terms' has grown logarithmically at a pauky 2.7% p.a., while the value of the pound has fallen at an average rate of 6% p.a. (largely, no doubt, because of an increase in the money supply). As I have pointed out elsewhere [3], that which the Office of National Statistics calls growth of GDP is very largely inflation.

If that 9% 'growth' were to persist, it would still make sense for our average citizen to borrow £30,000 to buy a house; in 30 years time, when the debt was due to be repaid, it would only feel like £2260.  But, with an economy in stasis and house prices sinking, the average adult will be less able to repay in 30 years than he is today; he is going down the chute. Not the banks, however.

Loans fall into one or other of two categories: productive loans (for the purchase of industrial plant, land, farm stock, education, etc.), and non-productive loans (consumer goods, food, luxuries, accommodation). It makes sense to borrow, or lend, money for the former. It makes no sense to lend for the latter, yet that is the preferred type of loan for the bank. Particularly loans for housing, for, with the (supposed) security of the title deeds, there is very little risk. Banks are neither patriotic nor philanthropic; they are there to make money, even if their activity is bad for the country and bad for the customer. For a decade or two after the war, the lending by banks was under fairly strict governmental control. Perhaps we need to return to such thinking.






L. Cawstein

Monday, 6 August 2012

"Capital Justice"

"Capital Justice"

Open letter in response to a Radio 4 talk by Helena Kennedy – 6th Aug 2012

Dear Helena Kennedy,

Your intriguing talk on "Capital Justice" must (I think) have been chopped around by the producers, inserting unnecessary quotes and bits of even less necessary music. I suggest this with some humility for I acknowledge my weak ability to follow a complex argument at first hearing (and with enormous respect for your integrity, and expertise).

         I suppose you might have started your essay with a question like one of the following:

[a]  Could the law have prevented (or punished) the injustices of the financial crash?
[b]  Surely it is (or could be made to be) illegal for clever people to take money off foolish people (as, for example, laws that regulate the sale of patent medicines).

You might have decided early on that you would end your piece with the Adam Smith quote: " less essential to the existence of society than justice."  This especially as the other authors you quote en route tend to contradict each other.

I think you hinted at, but did not state, another proposition that deserves italics: Commercial companies must never be allowed to get bigger than the Nation State; if they cannot be confined (and controlled), the Nation States must themselves combine till they have sufficient power to exercise control. 

You (successfully) pointed out that people cannot be punished for behaving badly; only for breaking the law; and that the law is made by judges. Yet I would offer another proposition which I submit you significantly fudged: Democracy and "Mob-Rule" are not in conflict; they are in fact the same thing. Justice and morality are generated by the 'demos'. Laws are made by judges in response to justice and morality.

How might you traverse successfully from the question at the beginning to the Adam Smith quote at the end without creating the feeling of wandering in a dark forest seeming to pass the same landmarks over and over? No doubt you wanted to incorporate the quotations you had collected on your tape-recorder; but should you try to contrive a sequence progressively driving at one conclusion, or pair the quotations off so that they negate each other and amount to nothing, while successfully indicating the complexity of the situation?

Much of the miss-selling of mortgages and miss-classification of risk, the ill-considered acquisitions, investments and reward systems — perhaps these do not break the law. It is (after all) still legal to offer money at high interest (because at high risk) against the surety of title deeds (which bear no risk; you win if they continue to pay, you win even better if they default). It is still legal to sell lottery tickets (which is simply taking money off people, giving half back and keeping the other half). Why is this not made illegal? Probably because it is too difficult to make laws that control all the tricky ways of making money, though there may be some lack of will among the law-makers.

However, there are laws against fraud in the United States of America (we heard), so surely also in Britain. And, if not, why not? To rate, as AAA, a bond that is plainly irrecoverable bad-debt, would seem to be fraudulent; so why no prosecutions in Britain? (Here you could usefully inform the lay listener: does the law have to show knowledge of the fraud to make it criminal? Is that impossible? Are there any prosecutions pending?) Paying taxes is legally required; are these taxes being rigorously pursued? If a bank is given public money, is that money ever returned to the State, with appropriate interest? (In which case, what is the problem?)

Could it be that Government is too friendly with the bankers, or too much in awe, or too dependent? Any such suggestion should be taken very seriously, and acted upon. But that (you might say) is a matter of politics, not law. Helena Kennedy loves the law. Some 200 years ago it was perfectly legal to drive a whole countryside to starvation simply by raising rents, and outlawing vagrancy. At the same time poaching a rabbit was made a serious crime simply by declaring the wild game on land to belong, not to nature, nor to the tenant farmer who raised the corn, but to the 'gentleman' who owned the land. Because the law was in the hands of the gentry. However, the law was changed; changed by the demos; changed painfully slowly, and only when the pain became unbearable. The law must go on changing. 

 Yours sincerely, Cawstein,

Longhirst, Northumberland.