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ANALYSIS OF HISTORICAL CONSTRUCTION COST MOVEMENTS IN SCOTTISH SOCIAL HOUSING FINAL REPORT

APPENDIX B

Comparison of Retail Prices Index (RPI) and Gross Domestic Product (GDP) Deflator to Convert Nominal Cost and Price Trends to Real Cost and Price Trends

The research requires an examination of real capital, management and maintenance costs, tender prices and output prices. 'Real terms' are defined by HM Treasury as "figures that have been adjusted for changes in the purchasing power of money".

All of the index series examined for this research have been published in nominal terms. To adjust for "changes in the purchasing power of money", the figures in a nominal index series need to be divided by an index that reflects those changes in the purchasing power of money i.e. an index of inflation.

The most widely known measure of inflation is the Retail Prices Index (RPI). The RPI is defined as a measure of change in the prices of goods and services bought for the purpose of consumption by the vast majority of households in the U.K. RPIX is a similar measure but excludes the cost of mortgage interest payments. RPIY excludes all housing costs. The Harmonised Index of Consumer Prices (HICP) has been developed as a Europe wide comparable measure of inflation but was launched only in 1997.

Specifically, the RPI includes data on food and drink, tobacco, housing, household goods and services, personal goods and services, transport fares, motoring costs, clothing and leisure goods and services. Table B1 shows the weights of the various item categories within the RPI in 2002.

Table B1 Retail Prices Index - section weights for use in 2002

The GDP Deflator is derived from the ratio of the current and constant price series for Gross Domestic Product. As such, the GDP deflator can be viewed as a measure of general inflation in the domestic economy. The GDP deflator reflects movements of hundreds of separate deflators for the individual expenditure components of GDP. These components include expenditure on such diverse items as bread, investment in computers, imports of aircraft, and exports of consultancy services.

In practice, the RPI, RPIX and the GDP deflator tend to move broadly together over a period of time though they can diverge in the short term.

Chart B1 graphically displays the movement over time of the GDP Deflator compared to RPI. The GDP Deflator is calculated by HM Treasury from ONS data for GDP. HM Treasury publish the GDP Deflator with a base date relating to the last full financial year. Chart B1 has been drawn with a base date of financial year 2001-02 as 100. The current series of RPI has a base date of January 1987 as 100. Consequently the chart has been plotted by financial year back to 1987-88.

Chart B1 Retail Prices Index and GDP Deflator Compared

The accompanying table above emphasises the very close relationship between the two inflation measures over almost any period of time.

In essence, the GDP deflator is a measure of the movement in prices of UK inputs into the economy, (especially of wages and profits), whereas the RPI relates more specifically to price movements of goods and services purchased for consumption by households. Therefore the coverage of the GDP deflator is wider than that of the RPI, and it is this which makes the GDP deflator more appropriate for use when deflating public expenditure series. For this reason, also, the GDP deflator has been considered the most appropriate measure of inflation for deflating nominal cost and price trends in this study to real cost and price trends.

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