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Published on May 16th, 2011 | by Pete

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Inflated Importance?

You’ve probably heard the word inflation bandied about a lot, especially at the moment. So what is all the fuss about? What is inflation, and why should we care? Read on…

What is inflation?

Inflation is the rate of change in the prices of goods and services that we buy, and it is a key issue in economics.

Why is inflation important?

The reason it is such an important issue is that it impacts on the interest rate that we get on all of our savings, as well as the level of interest applied to our mortgages. Inflation will also have an affect on state pensions, our income levels, and benefits, as well as the price of tickets to use public transport; so the consequences of changes in inflation can be far reaching for all of us.

Also, the Government and businesses use inflation data to help set economic policy. For example, the Bank of England will use inflation data to help determine at what level to set interest rates. This means that if they think that in the next 18 months inflation will be above 2%, they may decide to increase interest rates in order to reduce inflation. This is why at the moment there is a lot of talk about increasing inflation putting pressure on the Bank of England to raise interest rates from the current level of 0.5%.

How is inflation measured?

There are a number of different measures of inflation currently in use. The most common measurements discussed and quoted in the media are the Consumer Price Index (CPI) and the Retail Prices Index (RPI). Both of these work in much the same way; by taking hundreds of items we all regularly spend our money on, such as bread, beer and cinema tickets, and tracks how the prices of these items has changed over a period of time. The rate of inflation is expressed as a percentage. So, for example, if the CPI is 3%, this means that on average, the price of services and items we buy is 3% higher than the year before. This would also mean that to buy everything we bought last year would cost us 3% more than it did then.

What is the difference between the CPI and the RPI?

The main difference between the two different measurements of inflation is that the RPI includes housing costs, such as council tax and mortgage interest payments, whereas the CPI does not.

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