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Q&A: what is happening to inflation?
Inflation measures may just seem like a confusing bunch of acronyms but they have been causing the government a headache.
by Michelle McGagh on Jan 10, 2013 at 12:35
The outcome of a consultation on measures of inflation has been welcomed as good news for pensioners and savers, but just what exactly is the impact?
The Office of National Statistics (ONS) confirmed today that it would not be changing the measure of inflation used for uprating pensions from the current retail price index to the consumer price index.
It may seem like an abstract concept but it has a large impact on pensions and savings.
What are RPI and CPI?
The retail price index (RPI) and consumer price index (CPI) are ways to measure inflation. Both measures look at the price a basket of set goods to determine whether inflation, and the cost of the basket, has gone up or down.
The reason there are two measures is because the RPI takes into account some extra items such as housing costs and council tax. As these items tend to rise at a fast pace it means the RPI inflation rate runs higher than CPI.
Currently inflation measured by the RPI is 3.2% while CPI inflation in 2.7%. The CPI is the rate that the Bank of England’s inflation target is set against – the target is currently 2%.
Is one measure more accurate than the other?
Neither of the inflation measurements are an exact science and unfortunately both are susceptible to the ‘formula effect’.
Both measurements are based on a basket of good and services, and while it is easy to pin down the average price of some goods – such as milk and bread – it is more difficult to do so for other items in the basket, like clothes. You can buy a dress for £20 or you can buy a dress for £200.
This means that RPI is always higher. This could be because CPI is under-valuing goods, or it could mean that both measurements are wrong.
The national statistician Jil Matheson now wants to work on a new measure of inflation that helps iron out these problems.
What did the government want to change?
The government got the ONS to look at bringing RPI more in line with CPI, effectively reducing how quickly inflation rises.
Although none of us wants inflation to increase, because it means goods and services cost more, if a lower inflation measure is used then it impacts on investment and incomes that are linked to inflation because they rise more slowly.
More about this:
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