Inflation is a sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money
How is the rate of inflation measured?
The Bank is independent of the government with control of interest rates and it is free from political intervention. The Bank is also concerned to avoid price deflation
Falling inflation does not mean falling prices!
Please remember that a fall in the rate of inflation is not the same thing as a fall in prices! In 2009 there was a steep drop in inflation from 5 per cent to 1 per cent over the course of the year. Inflation was falling – but the rate remained positive – meaning that prices were rising but at a slower rate! A slowdown in inflation is not the same as deflation! For this to happen, the annual rate of price inflation would have to be negative.
How is the rate of inflation calculated?
Calculating a weighted price index
CPI is a weighted price index. Changes in weights reflect shifts in the spending patterns of households in the British economy as measured by the Family Expenditure Survey.
The following hypothetical example shows how to calculate a weighted price index.
|Category||Price Index||Weighting||Price x Weight|
|Alcohol & Tobacco||110||5||550|
Weights are attached to each category; we multiply these weights to the price index for each item of spending for a given year.
Limitations of the Consumer Price Index as a measure of inflation
New items added to the consumer price index in 2014
Items removed from the consumer price index in 2014
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