Proposed New Target Measure Of Inflation, European standard.

used are similar, the rules underlying the construction of the HICP are specified in a series of European Regulations and it differs from the RPI in the following ways:- In the HICP, the geometric mean is used to aggregate the prices at the most basic level whereas the RPI uses arithmetic means.- A number of RPI series are excluded from the HICP, most particularly those relating to housing costs (e.g. council tax) and in particular to owner occupiers' housing costs (e.g. mortgage interest payments, house depreciation, and buildings insurance).- The coverage of the HICP indices is based on the international classification system, COICOP (classification of individual consumption by purpose), which differs from the RPI groupings.- The HICP includes series for university accommodation fees, foreign students’ university tuition fees, unit trust and stockbrokers’ charges, none of which are included in the RPI. - The index for new cars in the RPI is imputed from movements in second hand car prices, whereas the HICP uses a quality-adjusted index based on published prices of new cars.- The index for personal computers in the RPI uses the 'option cost' method for quality adjustment, whereas the HICP uses a 'hedonic regression' method for quality adjustment.- All private households, foreign visitors to the UK and residents of institutional households, base the HICP weights on expenditure. In the RPI, private households only base weights on expenditure, excluding the highest income households, institutional households and pensioner households mainly dependent on state benefits.- In the construction of the RPI weights, expenditure on insurance is assigned to the relevant insurance heading. For the HICP weights, the amount paid out in insurance claims is distributed amongst the COICOP headings according to the nature of the claims' expenditure with the residual (i.e. the service charge) being allocated to the relevant insurance heading.Is the HICP revisable?Unlike the RPI & RPIX, the HICP is revisable, but only in the following circumstances:- if the figure is originally published as provisional- if a mistake is found in either the basic data or in the calculation of the HICP, and- subject to approval by Euro stat, if new or improved basic information becomes available which is considered necessary in order to improve the accuracy of an HICP.For how long has the HICP been produced?The Official index started in January 1996 with the first Official annual rate being available in January 1997. The index base of the Official index is average 1996 =100. Estimates prior to this date have been produced, details of which are in an Economic Trends article available on the website (under ‘Related Links’).Is the HICP better than the RPI/RPIX?Each has its relative merits. The HICP is constructed according to Euro stat guidelines and is therefore standardised across the EU. It is also the measure designed specifically for use by the ECB in setting interest rates to target inflation under Monetary Union. The RPI, on the other-hand, has been used for a number of purposes including the indexation of benefits as well as targeting inflation. Although we have no reason to suppose that RPIX has not functioned well in the past as a target measure of inflation it was not specifically developed for this purpose.For an inflation target is the geometric mean more appropriate than an arithmetic mean?The main distinction between the two in this respect is that the geometric mean produces a lower figure because of its implicit assumption about consumer behaviour to relative price changes. The geometric means assumes that consumers will buy less of an item in proportion to the price increase relative to its competitors and vice versa. For example, if the relative price of one variety of baked beans doubles compared with its competitors then the quantity purchased of that particular variety is assumed to halve.For international comparisons the geometric mean has the advantage of providing better comparability as it is less influenced by detailed differences in index construction. This was one of the reasons why it was adopted by Euro stat.Why such a big numerical difference between the geometric mean and the arithmetic mean (currently 0.44 percentage points)?This relates partly to detailed issues associated with sample design (which lead to the arithmetic mean of price changes giving a higher estimate than the geometric mean) and partly to differences in the assumptions about consumer behaviour, which underlie the two formulae. For instance, unlike arithmetic means the geometric mean allows for consumer substitution between very similar or identical products when the price differential changes. Consumer substitution can take place between different brands of the same good and between the identical good sold at different outlets.What is the inflation target for the UK?The inflation target for the UK continues to be an annual increase of 2.5% in RPIX. In his statement on the UK government's policy on Economic and Monetary Union (EMU) on 9 June, the Chancellor said that he had written to the Governor of the Bank of England stating that subject to confirmation at the time of the Pre-Budget Report he intends to change the inflation target at that time. The inflation target for Britain will then be set on the HICP definition. However he confirmed that pensions and benefits and index-linked gilts would be calculated on exactly the same basis as now