RPIX AND HICP
Part 1: A technical note prepared by the Specialist
on the difference between the RPI and the
1. This note demonstrates
that the HICP will always be lower than the RPI, and that the
difference becomes larger, the greater is the difference in the
inflation rates of the individual items that make up the index
(i.e. the variance of the individual item inflation rates). For
example, a shock that affects the inflation rates of the individual
items differently, such as a change to the exchange rate, will
make the two indices diverge.
2. RPIX is an arithmetic weighted average
of price relatives. HICP is a geometric weighted average
of price relatives.
3. The weights are previous expenditure shares. In
the RPI these are up-dated annually, and are not the current expenditure
shares. Thus the weight on the ith good is:
8. This can be interpreted as:
9. If the rates of growth of the individual prices
(the individual inflation rates) are not identical, the RPI will
be greater than the HICP.
10. the greater the differences in the rates of growth
of the individual prices, the greater the divergence between RPI
11. In practice, the individual price changes will
tend to be different when either demand or supply conditions are
different. An example is an exchange rate change. This is likely
to directly affect the traded goods and services sectors, but
not the non-tradeables sectors. Any effect on the non-traded sectors
will be indirect and hence later.
12. Although there may be differences between the
RPI and the HICP, if financial markets understand the differences,
switching from using RPI to HICP ought not to have much effect
on interest rates.
Part 2: Extract from the memorandum submitted
by the Office for National
Statistics on the differences between the
RPI, the RPIX and the HICP
The Retail Prices Index (RPI)
The Retail Prices Index is the main
domestic measure of inflation in the United Kingdom. It measures
the average change from month to month in the prices of goods
and services purchased by most households in the United Kingdom.
The expenditure of certain higher income households and of pensioner
households mainly dependent on state pensions is excluded, as
their expenditure patterns are considered atypical.
The three major uses of the RPI are
- A macroeconomic indicator to monitor
- Income adjustment such as uprating
social security benefits, state pensions, and the capital value
of index linked National Savings and gilts, and for wage bargaining.
- Price adjustment, for example setting
prices in private contracts and regulating prices of privatised
The index is compiled using a large
and representative selection of more than 600 separate goods and
services for which price movements are regularly measured in 146
areas throughout the country. Some 120,000 separate price quotations
are used each month in compiling the index.
The RPI is constructed using two forms
of arithmetic mean. The average of relatives is used when prices
have a wide range or goods are dissimilar, whilst the ratio of
averages is used when prices are similar or goods are homogeneous.
The methodology underlying the construction of the RPI has been
developed and approved by RPI Advisory Committees over many years.
Once published the RPI is never revised.
RPI excluding mortgage interest payments (RPIX)
RPIX is the measure used as the government's
inflation target. It is constructed in exactly the same way as
the RPI except that it excludes mortgage interest payments. It
is a more appropriate tool for monetary policy purposes because
by excluding mortgage interest payments it does not reflect the
direct impact of interest rate changes made to control inflation.
The harmonised index of consumer prices (HICP)
The harmonised indices of consumer prices
(HICPs) are calculated in each member state of the European Union
for the purposes of European comparisons as required by the Maastricht
Treaty. The official series starts in January 1996. From January
1999 it has been used by the European Central Bank to measure
price stability across the Euro area. Within the United Kingdom,
its main use is for comparisons of inflation with other EU countries.
The construction of the HICP is specified
in a series of EU Regulations agreed between Eurostat (the Statistical
Office of the European Community), the European Central Bank and
Member States, which are intended to ensure that the indices from
different countries are comparable. The comparability of methods
is designed to ensure that the calculation of annual inflation
rates does not differ for methodological reasons by more than
0.1 percentage points.
The HICP uses the same basic data as
the RPI but with some important differences in coverage and methodology:
- the geometric mean is used to aggregate
- It excludes a number of RPI series
most notably those relating to owner-occupiers housing costs (mortgage
interest payments, house depreciation, council tax and buildings
insurance). The HICP also currently excludes some health, education
and insurance expenditure - these will be introduced in December
- the HICP includes air-fares which
are currently excluded from the RPI;
- The HICP index for new cars is a
quality-adjusted index based on published prices of new cars,
whereas the RPI uses used cars as a proxy for prices of new cars.
The latter was recommended by a previous RPI Advisory Committee;
- Weights for insurance, particularly
the service charge element, are constructed according to different
rules. For instance in the HICP the weight for claims expenditure
is distributed according to type of expenditure (eg car repairs,
spare parts) whereas in the RPI it is presented under specific
insurance heading (eg house contents, motor);
- The average household expenditure
pattern on which the HICP is based is that of all private households
(and therefore includes certain higher income and pensioner households,
which are not covered in the RPI).
Provision is made in the Commission
Regulations for the HICP to be revised. This enables retrospective
adjustment to the coverage of the index
Which index for which purpose?
The ONS recognise that no single measure
on inflation can meet all users' needs. That is why we publish
a variety of measures. The RPI is the "headline" measure
of consumer price inflation as it measures the widest range of
price changes that affect the majority of private households.
It is the main domestic measure of inflation in the United Kingdom.
RPI(X), which excludes the impact of mortgage interest payments,
is arguably a better indication of "underlying" inflation
for monetary policy purposes and is used by the Government for
its inflation target. The HICP is calculated in each Member State
of the European Union according to standard methodology and is
therefore the most appropriate for making comparisons within the
EU since such comparisons are not hindered by differences in the
way each country compiles its index.
Choice of aggregation formula
The choice between geometric and arithmetic
means for combining price data at an elementary (unweighted) level
depends both on the purpose for which an index is intended and
its conceptual basis. This requires a judgement about the relative
statistical merits of the formulae concerned. An index constructed
using one formula is not necessarily more accurate than an index
constructed using a different formula. In the development of
the HICP no judgement was made on the technical merits of each
formula: the United Kingdom HICP uses the geometric mean because
it produces comparable results between countries and helps to
ensure that differences in inflation rates are not due to differences
in the formulae used to create indices at the most basic level.
One of the two types of arithmetic mean used in the RPI (the
ratio of averages) also has this property and can also be used
in the HICP. The other type of arithmetic mean (the average of
relatives) leads to non-comparability and is therefore barred.
In February 1999, the different formulae
used in the HICP and RPI accounted for about half of the 0.9 percentage
points difference between HICP and RPIX annual inflation rates
(the derivative of the RPI most closely matching the HICP in coverage).
The remainder of the difference is due to coverage (see below).
|Breakdown of differences (unrounded figures)
||housing components excluded from HICP
(net vs gross)
|other coverage differences
Difference due to use of different formulae to aggregate prices
at the most basic level.
The three inflation measures described
above are price indices which are constructed from raw price data
and which are designed specifically to measure price changes.
The GDP deflator and consumers' expenditure deflator - commonly
referred to as "implied" measures - are not directly
calculated from raw data. They are derived from a comparison
of National Accounts economic series measured in current and constant
(eg 1995) prices.