Inflation is without doubt one of the most important measures in economics.

This measure is used in many ways by governments and businesses, and has a critical role to play in setting economic policy. It determines the interest rate we pay on our mortgages, the rate we get on our savings, and even the level of benefits and state pensions we get.

So as you can see, far from being an abstract idea for only economists to worry about, inflation affects us all.

 

Inflation Explained

Inflation is the general rate at which prices for goods and services are increasing. When governments publish the latest inflation rate figures, they usually represent a comparison of prices for a range of goods and services used commonly by most households. Inflation is calculated by looking at how these prices change over a period of time, usually since the previous year.

 

The Basket of Goods

The most recent Basket of Goods compiled by the Office for National Statistics feature a few more interesting and fashionable items – such as protein powder and e-cigarettes – as well as staples which have been in there since the first basket in 1947, like bacon, bread, milk and petrol.

 

In Practice

Typically, inflation rates are expressed as percentage figures. So for example, if inflation was at a rate of 2.5%, it indicates that the cost of goods and services we purchase are on average 2.5% higher than they were at the same period the previous year. This means that, as consumers, we would need to spend 2.5% more to purchase the exact same goods and services we bought a year ago.

 

What are CPI and RPI?

These are the two most common and significant measures of inflation, namely the Consumer Price Index (CPI) and the Retail Price Index (RPI).

Both are very similar in many respects, as they measure the prices of hundreds of goods and services households commonly spend their money on. However, there are some other important differences between CPI and RPI:

RPI includes prices such as mortgage interest payments and council tax payments within their data, whereas CPI doesn’t.

CPI uses a different formula when calculating its rate. Instead of calculating a like-for-like basket of goods over a period of time, it measures a basket of goods that varies over time – this is mainly due to consumption patterns changing, resulting from either a rise or fall in living standards. This ordinarily results in the CPI rate being lower than RPI in most cases.


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