Sunday 15 May 2011

Posted by Jake on Sunday, May 15, 2011 with 2 comments | Labels: , , , , , , , ,

The financial competence of Gordon Brown, the former Chancellor and Prime Minister until the ejection of the Labour government in 2010, was exposed with hindsight by his government’s failures in protecting the British economy from the Credit Crisis that started in 2008. However, the evidence of financial dizziness in the rarefied atmosphere he once sucked up was there in his earlier statements.

When, in 2008, Brown was pushing for a long-term pay settlement with public sector workers, he stated

It seemed that Brown hadn’t got to the chapter in his economics book that would have taught him: it is not only certainty on your pay that provides stability, it is certainty on the cost of your bills. To be charitable we must assume this was simply too difficult for Brown to comprehend – as the alternative would be that he was being, shall we say, misleading. 

The Bank of England’s own inflation projection – its estimate of what inflation is likely to be over the next few years – shows that nobody really has much idea where inflation is going. Bank of England estimates for the next few years show inflation is likely to be anything between –0.5% and 4.5%.

Just as Labour pulled a fast one with inflation back in 2008, so are the Conservatives in 2011 with their change in the indexation of pensions from a link with the Retail Price Index (RPI) to the Consumer Price Index (CPI).

The sheer uncertainty of inflation can be seen in the Bank of England's historical record.

Which in itself can be misleading. Between 1790 and 1900 there was chronic volatility. But the large upswings were quickly followed by large downslides. In contrast, after 1900 it was a pretty continuous upswing. Which can be seen in the Bank of England’s “inflation calculator”, showing how prices changed in 50 year steps

  • from 1750 – 1800           -           prices went up by 2.7 times
  • from 1800 – 1850           -           prices went down by 0.6 times
  • from 1850 – 1900           -           prices went up by 1.1 times
  • from 1900 – 1950           -           prices went up by 3.6 times
  • from 1950 – 2000           -           prices went up by 20 times

What this means is:
  • In the two hundred years from 1750 to 1950, goods & services that cost you £10 in 1750 would have gone up in cost to £65.
  • In the next 50 years, to 2000, the price would have gone up to £1,317.

After 1950, inflation has been on a one-way upward road. This is why indexation is important to everyone – and particularly important to those who have no control over their income, such as pensioners who rely on their purchased annuities and the state pension. The Retail Price Index (RPI) was created to provide a way of protecting workers and pensioners from price increases. In 1996 the government created a new measure of inflation, the Consumer Price Index (CPI), which by its design is lower than the RPI. Having these two measures of inflation provides wiggle room to discriminate on how quickly government taking (e.g. taxes) and government giving (e.g. pensions) should inflate.

According to the government’s Office of National Statistics, the two measures of inflation represent different groups
  • The RPI is representative of the majority of private UK households, but excludes the highest earners and pensioner households dependent mainly on state benefits. It includes expenditure both within the UK and abroad by UK households.
  • The CPI is representative of all private UK households, and also includes the expenditure of institutional households (nursing homes for example) and foreign visitors to the UK.
You may have thought from this that RPI is more representative of an ordinary British pensioner's living costs than CPI. Apart from tourists, CPI also includes “institutional households”, which are defined by the OECD as
1. Educational institutions
2. Health care institutions
3. Institutions for retired or elderly persons
4. Military institutions
5. Religious institutions
6. Other institutions.

After all, the requirements of nuns and squaddies billeted in cloisters and camps are not typical of your average pensioner. However, CPI is lower than RPI. So the Conservative led government in 2010 changed the link for pensions from RPI to CPI – to reduce the amount paid to pensioners.

CPI is a grand simplification of prices. It is made up of a basket of goods and services, each of which has its own inflation rate.  The price of clothing has been dropping for well over a decade, while the price of fuels (electricity and gas) has been spiralling.

However while the CPI basket of goods tracks the spending of people who are still working, it doesn’t match the pattern of spending of an average pensioner. People over 65 spend a bigger part of their budget on food & non-alcoholic drink, and less on clothing.

Pensioners have been particularly hit by swingeing increases in fuel costs – electricity and gas – with the number in “fuel poverty” doubling from 463,000 in 2003 to 967,000 in 2007. 

Fuel poverty is just one facet of pensioner penury. In a speech in the House of Commons in February 2011 the Conservative MP Bob Stuart stated that in the UK:

  • 1.8 million pensioners live in poverty
  • between 20,000 and 25,000 pensioners a year in this country are said to die from hypothermia
  • 28% of all pensioners have less than £1,500 in savings
  • The Department for Work and Pensions estimates that 39% of pensioners fail to claim their benefits. That amounts to between £3.1 billion and £5.4 billion a year unclaimed.
If you are still not sure what the impact of the change from RPI to CPI will have on you, then the graph below ought to make things a bit clearer. If you are going to retire anytime in the next couple of decades, and the levels of CPI and RPI are about the same as the last couple of decades, then the loss in value of your pension, using government CPI and RPI data, will look like this:

The longer into the future you are going to retire, the larger the impact is likely to be.

But in times of crisis, governments need to save money. Pensioners are a powerless and easy target. The rest of us, thinking only of the present, forget that one day we too will be pensioners - assuming we live that long!


  1. Interesting impact assessment by the DWP here: "Impact of the move to CPI for Occupational Pension"

    It states that the net monetary effect of this policy is £83billion:

    "The main cost of this policy is to members of private sector Defined Benefit pension schemes who will see the anticipated value of their pension rights reduced and the value of their total remuneration package reduced in the short term."

    "The main benefit of this policy is to sponsors of Defined Benefit pension schemes [i.e. companies] who will see the value of their pension liabilities reduced and the cost of the total remuneration package for their employees reduced in the short term."

  2. Some people have tweeted about the 'triple lock guarantee', in which George Osborne promised pensions would rise by at least 2.5% even if inflation is lower than that. While this is a promise, it isn't the law.

    Also CPI inflation has also never been below 2.5% in the period between 2010-2013. So the promise has never been tested.

    The LibDems, in June 2014, said they would make this 'triple lock' law should they be in a position to do so, promises are promises they aren't the law.


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