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Thursday, 14 May, 1998, 13:12 GMT 14:12 UK
Inflation fundamentals
inflation
The government's inflation target is the cornerstone of economic policy. Therefore the rate of change in retail prices provides a key economic indicator.

There are many different ways to calculate inflation. In the United Kingdom, the standard method to measure price rises is the Retail Price Index (RPI), which is released monthly by the Office for National Statistics (ONS).

It is designed to give a measure of price movements for what is seen as the "typical" consumer.

How is it calculated?

The RPI is one of the most accurate economic statistics because it is based on a detailed survey of prices across the country.

The index measures the price movement of more than 600 goods and services in 146 areas.

Each month, around 120,000 prices are used to calculate the overall index. The result is published on the second Tuesday of the month.

Accuracy is paramount because the figures are used for the indexation of salaries, pensions and index-linked government bonds.

The weights used for the survey are adjusted every year in line with the results of the annual Family Expenditure Survey (FES).

Changes may also be instigated through an independent committee.

RPI-X

This is inflation excluding mortgage interest payments. Internationally, this is the most common method to calculate inflation.

In the UK, however, the RPI index does include mortgage interest payments.

A rise in interest rates to curb inflation increases headline inflation in the short run as mortgage interest payments increase. Hence, RPI-X is sometimes called the underlying rate and is used as the government's target.

RPI-Y

This is inflation excluding mortgage interest payments and indirect taxes.

Another key distorting effect results from indirect taxation. Value-Added Tax rates rarely change, but new taxes on alcohol, tobacco and fuels may distort the inflation index figures.

Measuring RPI-Y is most useful around December and January when budget duty increases come into effect.

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