Far from an exact science, measuring inflation has become a political tool

Let’s play inflation jiggery-pokery. The Office for National Statistics (ONS) was recently charged with deciding whether or not the Government’s energy bill handouts are a subsidy to companies or a transfer to households. This seemingly obscure question has big implications. If Rishi Sunak’s £37billion welfare package (soon to rise under our new PM) were deemed a subsidy, it could wipe two percentage points off the official inflation rates. But it isn’t, so it won’t.

I’ll try to explain. Energy bills are a large and growing component of the goods and services used to calculate the official inflation rates, CPI and RPI. These measures are designed to capture the cost of living for average punters, but not necessarily the actual cost of inputs to the whole economy. So if the government decides to freeze energy bills, as per Labour’s proposals, or caps them and bails out suppliers directly, as France has done, CPI and RPI go up by less, even though the cost of energy still soars. In such a scenario, taxpayers absorb the cost before it reaches utilities and their customers.

Clearly, this is not a real success in fighting spiralling costs. But it does affect the technical way in which the government structures its support. Huge chunks of the economy are linked to CPI or RPI, like the state pension, index-linked bonds, salary negotiations and tax-band thresholds (if and when they are unfrozen).

Pretending that inflation is lower than it is redistributes the cost of the energy shock in ways that are helpful to a cash-strapped Treasury. It reduces inflation-linked welfare payments and the pressure to uprate them. It slows the rising cost of index-linked gilts (an alarming volume of which have been issued in recent years). It enables employers, especially the government, to benchmark pay negotiations with staff and unions off a lower number. From a bean counter’s point of view, what’s not to like?

Yet all of this comes at the cost of accuracy and accountability. One critical decision linked to CPI is monetary policy. An artificially suppressed inflation rate would give the Bank of England further leeway to keep interest rates too low, increasing the risk of a wage-price spiral and more runaway inflation. Insofar as this puts off recession and the eventual reckoning with reality, it suits politicians. Suppressing CPI also allows them to claim some kind of credit for slowing inflation. Yet this ultimately weakens trust in officialdom and furthers the feeling that our political debates are taking place in a parallel reality sealed off from the one markets and voters perceive.

The Government hasn’t got away with it this time but it will try again. Only the ONS stands in its way.

It isn’t just rocketing gas prices that have surprised the experts. There is another inflationary force foxing them too: the labour market. For some reason or other, since Covid, the labour market has shrunk. Various reasons have been put forward, such as the incentive-draining impact of furlough payments, slowing migration or early retirement by older workers.

The data seems to show that these are all marginal factors, however. Instead, what has occurred is a mass-sickening of the workforce. Both the Labour Force Survey and disability benefits data suggest there are a lot more ill people around. Around 200,000 people now cite “long-term sickness” as their reason for not being economically active, while the numbers of people claiming one of the two main disability benefits has grown from 3.9 million before the pandemic to 4.3 million in February of this year. This may explain why there is a stubborn hangover of job vacancies that just aren’t being filled.

What is not yet known is the profile of these workers. Are they long Covid sufferers, or living with untreated ailments due to the collapse of the NHS? Or perhaps the Covid stimulus caused something to go wrong with our assessment of disability needs and many of these people could go back to work. Our new chancellor must get to the bottom of this mystery and fast.

Pretending that inflation is lower than it is redistributes the cost of the energy shock in ways that are helpful to a cashstrapped Treasury