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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

Q&A: what is happening to inflation?

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.

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5 comments so far. Why not have your say?

clive radley

Jan 10, 2013 at 17:52

It's a shame the article is spoilt by stating that RPI IS ALWAYS HIGHER THAN CPI. In 2009 RPI was negative for a while and significantly below CPI.

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James O'Connell

Jan 10, 2013 at 19:34

Is that significant?

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Ines

Jan 10, 2013 at 21:59

What is significant is that the government wants to understate the rate of inflation so they don't have to compensate pensioners and others whose incomes are linked to the rate of inflation - and they are just trying to work out how to do it without annoying too many people.

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James O'Connell

Jan 10, 2013 at 23:51

Ines

Absolutely correct.

Additionally, FTSE 100 companies have been lobbying the Tories to legislate in order that they can reduce their pension scheme increases to CPI. This has been going on for 18 months at least.

I suspect that the new measure of RPIJ is related to this. It is very worrying that nobody seems to know what RPIJ is and how it will compare with RPI and CPI.

Something stinks about this.

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Ian Lewthwaite

Jan 12, 2013 at 16:50

As long as it applies to EVERYBODY as it probably won't it will bring down the bill.

However, the Govts califudging the interest rates for savers, mainly pensioners also means that the interest rate on their retirement income is also reduced so they are hit twice at least , by Inflation on basics which relies on the staples, milk,bread, heating and lighting, which even to a blind man are more than the stated 2.7%.

Anyone who pays £200 for a new dress, if retired, is either rich or vain or both and does not cover anyone retired on average northern income

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