Memos on the faulty speedometer

183

In which Sir Humphrey Appleby wrestles with my musings on the retail price index?

From: Secretary of State

To: Sir Humphrey Appleby

I was reading an article by John Kay in the car this morning. All about taking someone called Linda to the Elizabeth Restaurant in Oxford. He went on to suggest that official statistics were all wrong. Is there anything in it? It might have big implications for the way we run the economy. Anyway, anything that might unsettle Gordon Brown could come in handy.

From: Sir Humphrey Appleby

To: Young High-flyer

Could you prepare a note on John Kay’s article in the Financial Times?

From: Young High-flyer

To: Sir Humphrey Appleby

John Kay’s article is witty and incisive as usual. He argues that measurements of the cost of living fail to take adequate account of the introduction of new goods, substitution between goods, and quality improvements. For example, what the Office for National Statistics does is to track the rising price of candles till people switch to electric light, and then track the rising price of electricity. They miss the key point that electricity is so much more efficient than candles that artificial light, once a luxury for the rich, has become an affordable everyday commodity. Changes like these are happening everywhere. As a result, calculations of inflation are far more uncertain than we acknowledge, and the inflation rate is probably overstated, perhaps substantially.

From: Sir Humphrey Appleby

To: Young High-flyer

I am not sure you understood my memorandum. Have a look in the departmental manual, sub-section 174 (3)A(iii) part 17.

Extract from departmental manual

The following format should generally be followed in response to external criticism of the department.

1. The points made in criticism of the department are incorrect.

2. The points made in criticism of the department, although correct, are already being considered and changes in procedures are being made to respond to them. The suggestions made by the critic would delay this process and worsen the situation he describes.

3. The critic is evidently unaware that his suggestions have already been fully implemented by the department.

In the light of 1,2 and 3 above, no changes in departmental procedures are required and no criticism of any member of it is warranted.

From: Young High-flyer

To: Sir Humphrey Appleby

Is this better? See attachment

From: Sir Humphrey Appleby

To: The Financial Times, Secretary of State

Kay’s article fails to acknowledge that the RPI is a measure of changes in the prices of a fixed basket of goods, and not of changes in the cost of living. In brief, the RPI is a measure of what it is the RPI measures, and is therefore entirely accurate. In any event, considerable progress has been made in adjusting the RPI to take account of quality improvements, and changes of the kind proposed by Kay might lead to over compensation. Officials have long been aware of the problems noted by Kay and readers and ministers can be assured that the RPI fully reflects them. While the matter is constantly under review, whatever is being done at the moment is the best that could possibly be done

From: Sir Humphrey Appleby

To: Personnel

Young High-flyer is showing evidence of Permanent Secretary material. Mark his file accordingly.

From: De Anne Dove

To: Monetary Policy Committee

I am interested in this suggestion by John Kay that the official inflation rate may be overstated. If he is right, we may already have virtually stable prices. Wouldn’t it then be time for an interest rate cut?

From: Governor, Bank of England

To: Monetary Policy Committee

Steady! If it were established that the inflation rate were overstated, the Chancellor might wish to make a corresponding adjustment to the targets set for the Monetary Policy committee. We need to consult the Treasury.

From: Permanent Secretary, Treasury

To: Governor, Bank of England

In framing his inflation target, the Chancellor was influenced by two principal considerations: the benefits of price stability as such and concern that inflation tends to accelerate when it rises above a very low rate. While he could not wish to influence the deliberations of the Monetary Policy Committee in any way, he is sure that these factors will be in the minds of the members of the Committee when they arrive at their independent judgement.

From: Deputy Governor

To: Monetary Policy Committee

There is a useful article in the Bank of England Quarterly Bulletin (August 1997) quantifying the benefits of price stability. Broadly, the main benefits are the result of the lower interest rates which price stability brings about.

From: Director General, CBI

To: Anyone who will listen

Isn’t this a bit odd? If the main benefits of price stability are lower interest rates, why are we putting interest rates up to achieve price stability?

From: Henry Hawk, from Holland

To: Monetary Policy Committee

Don’t be deceived by the siren voices of the CBI. We have been putting interest rates up recently in order to avoid having to put them up by even more in future. Broadly, the Chancellor’s two concerns reduce to one. Unless inflation is kept down to very low levels, it will spiral out of control.

From: John Kay

To: Readers of the Financial Times

Perhaps this helps to confirm my suggestion. Any inflation tends to accelerate. The reason we feel safe with inflation of 2½% or so is that measured inflation of 2½% corresponds to virtual price stability if quality improvement is taken into account.

From: Deputy Governor,

To: Monetary Policy Committee

The effect of the two issues the Committee has been considering is to offset each other. It may be that inflation has been overstated in the past. If this is the case, then the Chancellor should lower his inflation target correspondingly. Our views on what is a stable inflation rate are based on erroneous historic data. So if inflation continues to be overstated, we will come to the right decisions if we go on using the inflated figures. As the American economist Paul Krugman has put it, if you have got used to driving with a faulty speedometer, the best thing you can do is go on using it: you may drive worse, not better, if you have the speedometer fixed.

From Sir Humphrey Appleby

To: Secretary of State

Exactly, Minister

From Linda

To: John Kay

Of course I remember that dinner in the Elizabeth Restaurant in 1972. It was the most boring evening of my life. You kept on talking about economics. Something to do with price indices and inflation, if I remember. It was only the prospect of the crème brulée that kept me sitting there till the end of the evening.

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