measures the annual rate of change of the general price level in the economy.
Inflation is a sustained increase in the average price level.
Inflation and the Price Level
rise, the value of money falls. There is an inverse relationship between the
price level and the internal purchasing power of money. When there is
inflation money buys less in real terms. People can protect themselves
against the effects of inflation by investing in financial assets that give a
rate of return at least equal to the rate of inflation.
is extremely rare, although some countries experience it. In fact even when
the rate of inflation is rising, the prices of some goods will be falling.
Deflation is also fairly unusual although some countries such as Japan
and China have experienced price deflation in their economies in recent
years. In the United Kingdom,
the main measure of inflation is done through the Retail
Retail Price Index (RPI)
Price Index (RPI) measures the average change in prices of a representative
sample of over 600 goods and services. Each month, over 120,000 separate
price samples are taken to compile the inflation statistics.
is weighted according to the proportion of income spent by the average
household on categories of goods such as food and housing. These are
periodically changed to reflect changing consumer spending patterns in the
economy. For example the
weighting attached to food has fallen as average living standards have grown.
The weighting attached to leisure services and transport has increased
because these categories of spending have a relatively high income elasticity
Fuel & Light 4.1
Household Goods 7.2
Household Services 5.2
Personal Goods 4.0
Leisure Goods & Services 10.6
underlying rate of inflation, known as RPIX, was originally set a target of
between 1-4%. However, the Labour Government's target is for an average of
rate of growth of 2.5% over the duration of this parliament which ends in
2002. Inflation is allowed to move between 1% either side of the 2.5%
benchmark. The Bank of England
has been given the responsibility for meeting the inflation target. The chart
below tracks RPIX also known as
underlying inflation for the UK since 1988.
calculation of the RPIX is similar to the RPI, but excludes
mortgage interest payments. This is because when interest rates are increased
to control aggregate demand and inflation, the immediate effect is to
increase mortgage interest payments and, therefore, housing costs.
costs are a significant component of the RPI (see the table above), inflation
is artificially increased. Thus the very policy adopted to tackle inflation
actually creates a greater problem in the short run, and explains why the
Government discounts this component of the RPI.
the core rate of inflation, excludes
indirect taxes and the council tax on the inflation rate. By stripping out
the effect of these taxes, the Government can establish the core change of
prices within the economy. Cynics would argue that it is just another way of
reducing the headline rate.
measure of inflation has recently been introduced by countries within the
European Union. This is called the harmonised index of consumer prices (HICP)
and is meant to provide a standardised measure of inflation for each member
nation of the European Union.
Measures Of Inflation
inflation measures prices paid by firms for raw materials, components and
fuel. However, it does not include labour costs.
Over recent years the prices of essential inputs have stayed fairly
low. Indeed the rate of input price inflation has been negative for a long
period (see chart below). This has helped keep cost-push inflationary
pressure under control. These
are measured separately by Unit
Labour Costs (ULCs) which are calculated by dividing total labour
costs by output - to give the labour cost per unit of output.
A common misconception is that a rise in wages or average earnings
immediately places upward pressure on producer prices. This is not
necessarily true, since rising earnings may be offset by an equivalent
increase in productivity with ULCs remaining unchanged
at which finished goods leave the factory is measured by the Producer Price
Index (PPI). The PPI is also a good leading indicator of the RPI.
Base Rate Changes
Changes in the base rate since May 1992.
Yields on British Government Securities
Data going back as far as 1700.
Inflation data (Excel spreadsheet)