Inflation is defined as the rate at which the price of goods and services increase year on year – you’ll experience it as the cost of living increasing or decreasing over time.
Economists like a healthy bit of inflation (hence the Bank of England’s 2% target) because it shows growth in the economy. But if there’s too much, the cost of living spirals out of control – you may remember this as what happened in Germany after WWI. And if there’s too little inflation or even deflation, it’s an indicator we might be moving towards a recession.
The Office for National Statistics (ONS) provides three separate measures for inflation each month: Consumer Price Index (CPI), Consumer Prices Index including owner occupiers’ housing costs (CPIH) and the Retail Price Index (RPI).
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“The basket of goods” and how inflation is measured
All three measures of inflation are calculated using the price changes of a “basket of goods” containing items that the government thinks typical British people buy, ranging from food and drink to travel and clothing.
The items are weighted according to how important they are in the average household’s expenditure. For example, housing and transport eats more into the family budget than education and health, so the latter are given a lower weighting, meaning changes in their prices doesn’t influence the overall inflation rate as much.
The items in the basket change over time, and differ between RPI and CPI (CPIH is just CPI with cost of housing factored in).
Each month, the ONS collates the average prices of the basket of goods (approximately 180,000 prices for around 700 items) and compares them to previous year’s figures to work out the percentage change.
If there’s an increase, you have inflation. But if the figure is negative, you have deflation.
To really complicate things, all three are currently still in use. CPIH is what the UK government uses to track inflation, CPI is what the Bank of England uses for their target (which could influence how they adjust interest rates) and RPI is used in long term contracts (including some house leases and cost of rail fares).
The RPI and CPI use a similar basket of goods (albeit categorised differently), and each includes items that the other doesn’t. The CPI and CPIH contain university accommodation fees for example, but RPI doesn’t. Meanwhile, the RPI basket includes estate agents’ fees, which isn’t found in the CPI and CPIH measures.
And it’s worth noting that the items in the basket does change over time.
It means what gets chosen for this imaginary basket can be a fascinating insight into our society and how consumer tastes change over time.