Page last updated at 10:03 GMT, Monday, 15 September 2008 11:03 UK

Q&A: Understanding inflation

By Pam Davies
Office for National Statistics

Shopping basket
The price of food is part of what is monitored by the ONS.

What is inflation?

Inflation is the rate of change in the level of prices for goods and services, which affects the purchasing power of money.

There are a number of different measures of inflation in use today. The most familiar measure in the UK is the Retail Prices Index (RPI).

But monetary policy is now based on the Consumer Prices Index (CPI). Both measure the prices of products and services that consumers buy.

A price index is made up of the prices of hundreds of goods and services - from basic items like bread to new products, such as PCs.

How is inflation calculated?

Every month the Office for National Statistics (ONS) collects 120,000 prices of goods and services from a wide range of retailers across the country - including online retailers - ensuring that its indexes accurately reflect price variations throughout the UK.

Prices are updated every month and price collectors visit the same retailers each time in order to monitor identical goods and make sure they are comparing like with like.

All these prices are combined using information on average household spending patterns to produce an overall prices index.

We are more interested in the general increase in prices than individual price changes.

A payslip
Businesses often use the RPI rate in the setting of wages.

For the price change of any item, the impact on the overall index will be affected by the size of the price change and the importance attributed the particular item within the index.

A large rise in the price of petrol and diesel, for example, might affect the overall rate of inflation as it has a weight of 4% in the RPI, whereas a rise in postage charges is less likely to affect the overall index as they have a weighting of 0.1%

What are inflation figures used for?

The data from the CPI and RPI are used in many ways by the government, businesses, and society in general.

The RPI is used for the indexation of various incomes and prices and the uprating of pensions, benefits and index-linked gilts. It provides a series back to 1947, allowing analysis of price changes over time.

The CPI is the main measure of inflation used for managing the economy in the UK.

It uses methods that are consistent across the European Union, allowing comparisons of the rate of inflation across European countries.

It forms the basis for the Government's inflation target that the Bank of England's interest rate-setting Monetary Policy Committee is required to achieve.

Why am I experiencing greater inflation than the official figures?

Some reports claim consumers are experiencing sharp increases in inflation that are not reflected in the official figures.

These discrepancies do not mean that the official figures are inaccurate.

The consumer price indexes produced by the ONS are the most comprehensive and accurate available and are produced to the highest professional standards.

There are a number of reasons why individuals' experience of inflation may not match the 'headline' inflation figures produced from official data.

The headline figures are an average for all households and by definition will not be a match for everyone.

A primark store
The cost of clothes in the UK has fallen, the ONS says

People who spend relatively more of their budget on items with higher price increases, such as petrol, food and heating, will have a personal inflation rate that is higher than the headline CPI and RPI.

Similarly, people who spend relatively more on items with lower price increases, or even price decreases, such as clothing and electrical goods, will experience a lower personal inflation rate.

A further reason why trends in official rates may not appear consistent with individual experiences is that people tend to notice when prices are rising, whereas when prices are unchanged or even falling they make less of an impression.

This is particularly so when prices rise for items that are bought frequently.

For example, the price of foods such as bread, milk, eggs and butter, and petrol prices, have risen strongly over the past year.

On the other hand, clothing prices are falling but purchases are likely to be more sporadic and the items are less comparable.

Prices of electrical goods such as flat screen TVs and computers are also falling but these relatively large items are purchased infrequently and so are less noticeable.



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