'Upward bias' in RPI to be removed

Should the change be adopted it would come into effect in March 2013.

The ONS consulted with a range of specialists but the lead was professor of economics and internationally acclaimed index expert Erwin Diewert, who has been commissioned by the ONS to release a report with their consultation.

His report recommended “the RPI should drop its use of the Carli index as an elementary index” and replace it with the Jevons index, to fully align RPI with the consumer price index.

Professor Diewert said: “RPI uses two different formulae to calculate the rate of inflation based on prices that it collects, both of which use arithmetic rather than geometric mean, which can artificially raise inflation figures.”

The two formulae used by RPI are known as the Dutot and Carli formulae. Diewert believes the Carli formula has an upwards bias.

He explained: “This leads to RPI giving a much greater rate of increase in consumer prices than the Eurostat mandated Harmonized Index of Consumer Prices, which the ONS also compiles as CPI.

“The HICP realised the upwards bias problem with the use of the Carli formula and outlawed the use of this formula right from the start.”

Professor Diewert has previously written that the Carli index “should not be used” due to its inherent biases.

The effect of the government changing RPI to remove the formula effect would be substantial for UK pension funds.

Lynda Whitney, partner at Aon Hewitt, said: “If the removal of the formula effect goes ahead there is a complex set of significant impacts on pension schemes. The impact on members with benefits linked to RPI is clearly to reduce the value by about 6 per cent if impacted only in payment, and by about 15 per cent if impacted in deferment and in payment.”

“Schemes with investments in index-linked gilts will see the value of those assets fall. However, if their liabilities are also RPI linked then liabilities will fall more than assets, improving funding levels,” she added.

Kenneth Donaldson, head actuary at Capita Hartshead, said: “One effect is that this will level out the random effect introduced with the government change to CPI – some schemes ‘benefited’ (the members lost out) and some did not.”