The UK’s credit rating will fall victim to the failure to tweak RPI

WHEN asked who your favourite chancellor is, it’s fashionable to reply William Gladstone. He is the man who helped construct the Victorian liberal state, based on free trade and small government.

But while Gladstone was certainly brilliant, my own choice is Neville Chamberlain, who successfully steered Britain out of the 1930s Depression. It was a tragedy that his subsequent stint as Prime Minister was undone by the disastrous policy of appeasing the Nazis.

I thought of Chamberlain yesterday when the Office for National Statistics (ONS) said it had completed its review of the Retail Price Index (RPI) and, contrary to expectations, there will not be any changes.

The principles at stake here are very simple. Yesterday’s decision, presumably endorsed by George Osborne and his fellow ministers, further jeopardises the deficit reduction programme, and is another regrettable step towards the day when the UK may lose its AAA credit rating.

Here is why. The ONS admits that RPI overstates inflation. Those who are lucky enough to get their income automatically uprated every year in line with inflation, as measured by RPI, are benefiting at the expense of those who have no such guarantee – ordinary working taxpayers.

The use of RPI to calculate upratings for benefit claimants is, quite rightly, being gradually phased out by Osborne. But, following yesterday’s announcement, investors in the £250bn index-linked gilts market join the growing list of those “ring-fenced” from the impact of austerity, like the Department for International Development. The failure to tweak the RPI formula is likely to cost the Treasury another £2bn-£3bn a year.

So why did the Treasury give way? Apparently, big institutions threatened legal action. If that is true, those investors have shot themselves in the foot. What they gain by resisting such a tiny change, they will likely lose from the decline in sterling, which has already dropped three cents against the dollar since New Year.

Contrast this to the approach Chamberlain would have taken. Four years after the Wall Street Crash, the British economy was recovering well because Chamberlain knew that, if you are to balance the government’s books, everybody – including bond investors – has to put something on the table. By ring-fencing areas of public spending, not only do you make spending cuts fall more harshly on the remainder, you make your task more politically difficult by creating a sense of resentment.

Chamberlain implemented a massive conversion of the War Loan in 1932, reducing the coupon from 5 per cent to 3.5 per cent. At a stroke, he transformed government finances. The stock market and the gilts market soared. “We have finished the story of Bleak House,” he told the Commons during his 1934 Budget. “And are sitting down this afternoon to the first chapter of Great Expectations.” In Britain 80 years on, such decisive optimism remains some way off.

George Trefgarne is the author of Metroboom, Lessons from Britain’s recovery in the 1930s, published by the Centre for Policy Studies.