Keeping it real

Trends in real wages under the new inflation measures

Last month’s ONS Consumer Price Inflation release for February 2013 included for the first time two new inflation index series, the RPIJ (1997-2012) and the CPIH (2005-2012). These new measures have been introduced in response to concerns with the current RPI and CPI measures respectively.

RPIJ  is a modified version of the RPI, based on a slightly different mathematical calculation. It has been developed in response to a recent review of RPI by the National Statistician that concluded that RPI did not meet international standards because of the formula it uses (known as the ‘Carli’) to calculate prices for certain items in the RPI consumption basket. The new RPIJ measure is identical to the RPI in terms of the items it covers but addresses these concerns by using an alternative calculation method where necessary (known as the geometric ‘Jevons’ formula).

CPIH is a new measure of consumer price inflation that includes owner occupiers’ housing costs (including all costs associated with owning, maintaining and living in your own home (e.g. mortgage payments, dwelling insurance, maintenance and renovation)). Because these costs make up a significant share of spending for many households, it has long been argued that the standard CPI did not fully capture of the true cost of living. The CPIH has been developed in response to this critique.

So what difference do the two new measures make? Our previous work at the Resolution Foundation has highlighted the significant slowdown in median wage growth that occurred before the onset of the 2008 crash. Under RPI (our preferred measure because it covers a more comprehensive basket of goods than CPI) median wages showed almost no growth from 2003 to 2008. Under CPI median real wage growth also slowed but showed small positive growth.

Figure 1 shows the trend in median real wage between 1998-99 and 2011-12 under the four inflation measures: RPI, RPIJ, CPI and CPIH. Using the standard RPI measure to adjust for inflation, median real wages were barely any higher in 2011-12 than in 1998-99. The slowdown in real median wage growth is not so pronounced under other measures but the key finding of a post-2003 slowdown still holds. If RPIJ rather than RPI is used to adjust for inflation, median real wages are observed to have stagnated from around 2003-04. Similarly, real median wages exhibit a distinct slowdown from this point whether CPI or CPIH is used.

Figure 2 confirms the scale and duration of the slowdown in wage growth. It shows annual median real wage growth under the four inflation measures. Under all measures, annual wage growth has been falling steadily since 1999-00 and is now negative. The chart reveals that  until around 2006-07 the RPI and RPIJ growth rates were very similar, but diverged after this point with RPI consistently overstating inflation relative to the RPIJ measure. The wedge between the RPI and RPIJ median wage lines in Figure 1 is primarily driven by the divergence of these inflation measures from 2006-07 onwards. Similarly, the wedge between the CPI and CPIH median wage lines is explained by the fact that these measures diverge after 2008-09. This is the point when owner occupied housing costs began to grow significantly slower than prices overall as captured by the CPI.