IMPORTANT FACTS – Inflation
Inflation is the rate of increase in prices for goods and services over time. When prices rise, each £1 is worth less; therefore inflation also reflects the reduction in what you can buy for £1.
The main cause of inflation is money supply growing faster than GDP. Other reasons are the changing demand and cost for goods and services. For example, rice is more expensive than it used to be because more people are eating it (higher demand), while flooding and cold weather has reduced the crop in some countries (lower supply).
VIDEO– Check out the following video for a simple explanation of inflation (ignore the figures as they’re from 2012)
IMPORTANT FACTS – Inflation measures
- Inflation tracks the changing price of a representative basket of goods and services, which is regularly updated with consumer trends.
- The figures are compiled by the Office for National Statistics. The inflation rate is calculated every month by looking at the changes in prices of 700 goods and services in 150 different areas across the UK.
- This is known as the basket of goods and is regularly updated to reflect changes in the things we buy, hence the recent inclusion of tablet computers and Twilight books and the exclusion of casserole dishes and photo printing services.
The two main measures of inflation used are:
Retail Prices Index (RPI): includes mortgage interest payments, council tax and some other housing costs not included in CPI. The RPIJ is the improved variant of the Retail Prices Index and is calculated using a geometric formulation (known as the Jevons formula). The RPI in March 2020 is 2.7%. You can find latest RPI figures here.
Consumer Prices Index (CPI): includes some financial services not included in the RPI and is based on a wider sample of the population. It was 1.8% in March 2020. You can find the most recent CPI figures can be found here.
CPI is now more widely used as an inflation measure. CPI does not include housing costs.
VIDEO– Watch this for more about inflation- told by the Bank of England through a nautical theme…
The annual rate of inflation shows how much higher or lower prices are compared with the same month a year earlier. It indicates changes to our cost of living.
So if the inflation rate is 3% in January, for example, prices are 3% higher than they were 12 months earlier. Or, to look at it another way, we need to spend 3% more to buy the same things.
This is compared to the annual change recorded in the previous month to get an idea of whether price rises are getting bigger or smaller.
- If the annual rate has risen from 3% to 4% from one month to the next, prices are rising at a faster rate
- If the rate has fallen – say from 3% to 2% – prices of the things we buy are still higher, but have not increased by as much
- If the percentage rate is negative – for example, -1% – then prices are 1% cheaper than a year ago
TRIVIA
This calculator lets you compare prices in every year between 1901 and 2020. Below is a price comparisons of different items between 1960 and 2009, some examples:
IMPORTANT FACT- Why can’t we just print more money to pay off government debts?
The problem is that printing money would cause inflation (rise in prices) and effectively reduce the value of money.
If you print more money the number of goods and services will stay the same, you just have more money. Therefore people will be willing to spend more cash for the same limited number of goods, and the price of goods will rise.
An analogy: gold is valuable because it’s rare. If the supply of gold increased, it would simply reduces the value of a certain sized piece of gold.
See here for a more detailed but simple explanation.
Hyperinflation
This is very high levels of inflation – usually defined as more than 50% a month.
REAL LIFE EXAMPLES:
- In Zimbabwe between 2004 and 2009 there was a period of hyperinflation. By 2008 the annual inflation rate was over 230 million percent!
This was caused by the government printing money to fund a war in the Congo, made worse by government corruption and civil unrest.
It meant that prices for goods were increasing several times a day, and people were trying to change their money into other currencies, even though the government tried to ban that. Find full details here.
- Due to the increase of prices, one shop retailer in Wales had to change the names of his chain of pound shops from Famous £1 Shop to Famous £1.20 Shop (in April, 2010). The whole story can be found here.