What Is the Connection between CPI and Pensions?

The link between the consumer price index (CPI) and pensions is a controversial topic in countries that use the inflation rate to determine the amount paid in pension, because the choice of which price index to use can dramatically affect the amount paid. The CPI is one measure of inflation, and differs to other measures. One argument for CPI and pensions being such a big issues is that switching the index used to CPI can appear a merely technical measure, but in fact represents a significant cut to pension payments.

The precise calculation method of different price indices can vary from country to country. As a general rule, a consumer price index covers only goods and services that people may buy from businesses. A wider measure known as the retail price index generally also includes other living costs such as interest payments on mortgages and some property taxes.

In some cases, there is also a technical difference in the calculation method. This involves the way statisticians calculate the overall average of the changes of the various goods, services and costs that are measured. Another difference is that retail price index (RPI) generally only takes account of the prices being asked, while CPI takes account of how consumers respond to price increases, and whether they switch to cheaper alternatives. This can mean that, all other things being equal, a consumer price index will usually be lower than the equivalent RPI.

The arguments over CPI and pensions stems from the retirement benefits paid by some governments. These can to members of the public, paid for from either general taxation or specific contributions made by the employee through payroll taxes throughout his working life. The pensions may also be those provided by governments to retirees who have previously worked for government agencies and other public bodies.

In many cases, pensions paid by the government are automatically increased each year in line with inflation. The idea is that without this increase, the real value of the payment would be diminished. Some countries may also have laws requiring other pension payments, such as those made by private companies to former employees, to rise in line with inflation.

In some countries, governments have previously used RPI for this purpose but decided to switch to linking CPI and pensions. There are administrative arguments for this: for example, RPI includes mortgage costs, which are not relevant to many employees. However, critics of such changes argue that switching to CPI is a roundabout way to cut the amounts the government pays.