Two nations with two inflations
- Choice of inflation measure accounts for a third of the real-terms cuts to the basic rate of unemployment benefit since 2010
- The annual impact of high prices on the lowest-income 70% has grown over 17 years to be around £20bn higher than for richest third
- People who come to Citizens Advice have cut essential spending by around £220 per month — eating, heating and moving less to try and make ends meet. But it still isn’t enough to keep them in the black
We’ve been in two separate nations during this cost of living crisis.
In one, things have got tighter as inflation bites. For those of us who are comfortably off, the grocery bills have seemed uncomfortably high. We’ve worried about energy costs or mortgages going through the roof. It has meant adjustments.
We’ve been poorer. But we’ve been OK.
In the other, things are very different. Long squeezed by stagnant wages and real term cuts to benefits, for the poorest and those who are managing to get by — but barely — things have been harder. Wages might have increased a bit — but prices have gone up by so much more. For the very worst off, it’s been a downward spiral of having more you need to pay than you have money to pay for it.
At Citizens Advice, we’ve been overwhelmed by people needing our help. A full half of people who come to us for debt advice are in a negative budget, with more essential spending going out than coming in. And, as this analysis shows for the first time, they have perilously cut back on their consumption as well, a decision also forced on the poorest third of the population.
As well as a tragedy, it’s a puzzle. Why have things got so bad, at precisely the time the government ended the benefit freeze and wages have — in some months — outpaced inflation?
The Household Cost Indices (HCIs) are the best explanation of that puzzle we have. They show that we feel like two different nations in part because we face two different inflations — not just now but over the long term. The impact of prices in the richer nation has been £20bn lower than the poorer one.
To put it another way, they reveal how our prior picture was incomplete, mistaken and error strewn.
Those errors have had policy consequences. Politicians in the 2020s have wanted to support the poorest by maintaining benefits in real terms. But they haven’t succeeded, because they haven’t been given the right tools.
In recent decades, inflation has looked at all prices in the economy with no reference to who is paying them. The experience of the ordinary household has been flattened, ignored.
The HCIs seek to change that. They’re produced by the Office for National Statistics to provide a measure of household inflation which has been sorely lacking in recent decades. They include household costs that haven’t traditionally been included in Consumer Price Inflation (CPI) — like student loan repayments and mortgage interest. They weight households equally, unlike CPI, which is biased towards those who spend more.
They also look at the share that different households spend on different things.
That’s mattered enormously in the past two years in explaining why experiences of the cost of living have diverged so sharply. The poorest households spend a higher share of income on essentials like energy, rent and food precisely because they have so little left for anything else. And so if inflation is higher in these areas, any single inflation figure will understate the true impact for the poorest.
What’s that difference been? For the bottom 30% of the income distribution, inflation has been 4 percentage points higher than CPI over the past two years.
In the autumn statement, we’ve just seen that the Chancellor wanted to increase benefits by inflation. But because it’s been working off the wrong inflation figure, it has still — unintentionally — cut people’s incomes. For a couple with one child receiving benefits, that works out at about £36 a month.
But if you look at a longer view, the situation gets more dramatic. For this group, inflation has been 12% higher than CPI over the longest view we have — from January 2005 to now.
Figure 1: Gap between HCI Deciles 1–3 and CPI since January 2005
Let’s look at the rate of benefits since the government first started using CPI to increase benefits in 2010, compared to what would happen if you used the rate for the poorest 3 deciles in the Household Costs Indices.
The real-term cuts to benefits rates in the 2010s loom large here. If the basic rate had kept pace with CPI, the standard allowance would be £38 per month higher. But they would be about £60 a month higher if the lowest decile rate for HCIs had been used. Understating inflation for the poorest households therefore accounts for just over a third of the real terms cuts to benefits income in the past 13 years.
Every year I consume less and less
These errors have also led to a misleading picture regarding people’s purchasing power. How much you consume depends on how much money you spend on the one hand and how much the things you buy cost on the other.
If things turn out to cost more than we thought, that means you’ve also consumed less than we thought. That means putting less food on the table. Living in an ill maintained house without the means or power to improve it. Buying little luxuries at longer and longer intervals.
It’s here we see the biggest divide into two nations over the long run: for the richest 30%, prices run 1.2% lower than the headline CPI suggested, implying the richest’s spending went £370 further than we thought. But for the bottom 70% prices have been 7% higher — meaning their spending got them £855 less on average each year. Across the population, that looks like £17bn higher prices for the bottom 70% and £3.2bn lower for the top 30%.
Figure 2: Impact of price increases on real expenditure versus CPI
Let me add a caveat to this analysis. When you look at Household Cost Indices, you can’t avoid the conclusion that it’s lower for people on lower incomes. It almost always is, with some infrequent exceptions. That’s not true for the very richest — sometimes it’s higher, sometimes it’s lower. So there’s no guarantee that this relationship will maintain. But we can be much more confident that the pattern for poorer households will.
And indeed, in the past two years, the richest’s consumption has also declined compared to CPI. CPI has been understating inflation for everyone. But for the well off, the inflationary storm of the past two years has been more like an annoying drizzle. For everyone else, it’s been a far harder hit to real consumption than the official picture has, until now, suggested.
The choice of index makes a huge difference. But real consumption for the poorest has also decreased in absolute terms. The ONS has shown elsewhere that real expenditure has been stagnating by an even greater rate than disposable income has. For the poorest third, the HCIs reveal that while spending might be up by over 50%, people are able to consume less than they could 18 years ago:
Figure 3: Nominal versus HCI adjusted consumption for lowest third (per week)
The hardship Citizens Advice helps with
What happens to the people we help? We have excellent financial data for some of the people we help going back to 2019.
For the first couple of years of our data, our clients’ expenditures tend to match the Household Cost Indices almost perfectly.
But then the cost of living crisis hits. And for people coming to us, it’s a triple hit: a big increase in expenditure accompanied by a smaller increase in incomes, a gigantic increase in prices — and a huge hit from inflation-busting increases in housing costs.
The average person who comes to Citizens Advice for debt advice is now in a negative budget. What this analysis shows is that they are also having to reduce their total consumption by around £220 per month on average.
In the following graphs, the top line is how much expenditure would have had to go up to keep pace with inflation. The bottom line is how much they actually increased. What we see is they are:
Heating their home less….
Eating less…
And getting about less…
There’s one big exception. One essential where you just don’t have the option to reduce your consumption. And that’s the cost of housing. We can cut back on eating, heating and moving. But you can’t pay for half a house.
And it’s here we see the trend reversed. Private rents are running ahead of inflation. I think this points to a further flaw in all inflation indices including Household Cost Indices. A substantial one.
Some costs are just stickier for some people and some products. It’s helpful here to explore an example. Here’s Sarah — someone who came to us for help.
Her rent was £1000 per month — her landlord is putting it up to £1300. She’s been receiving temporary support from the council but that’s about to run out. She can’t downsize — letting agents say she’s not an attractive prospect for landlords with such a low income. She’s relying on food vouchers to feed her family, but that’s running out too.
There really isn’t much Sarah can do. Higher Local Housing Allowance is going to help. But fundamentally her rent costs are just sticky. She’s already making the cheapest choice she can make. And because it’s housing, she can’t reduce her costs any further. She can’t pay for half a house.
Whether it’s the HCIs or the CPIs, the way we measure inflation hasn’t captured this insight. Instead, the way they are constructed implies that for any increase in prices for a particular basic good, we can substitute away to a similar good that has had less of a price increase. So my favourite fancy pasta brand goes up substantially in price — no problem, I’ll just buy more value pasta in future.
But that won’t work for Sarah’s house. She’s trapped by this price increase, in a way statisticians have implied she isn’t.
It’s great that the ONS are improving our picture of inflation. In just the past fortnight, they’ve published the Household Cost Indices and new rent series data.
But they’ve spent years finding these problems. They should have asked one of our advisers.
