26/10/2010
Measuring
g
Inflation
A2 Economics, Autumn 2010
Key Concepts
• Price Indices
• The Consumer Price Index (CPI)
(
)
– Measures changes in the cost of living of a typical household
• The Cost of Living
– Is the quantity of goods and services that a given amount of
money (e.g. £1000 a month) will buy for a typical household
• Family Expenditure Survey (FES)
– This is the data used to calculate the weights used in the
consumer price index.
• The Inflation Rate
– The annual % change in the CPI. This is calculated relative to
some arbitrary base year set equal to 100
1
26/10/2010
Defining inflation
• Inflation is a sustained increase in the general price
level
• The rate of inflation is measured by the annual
percentage change in the level of prices
• In the UK there are several published sets of price
data
• Two main series are for the Consumer Price Index
and for the Retail Price Index
UK Consumer Prices - all items - annual index
1987 = 100
Index
220
The general price level in the UK
220
210
210
200
200
190
190
180
180
170
170
160
160
150
150
140
140
130
130
120
120
110
110
100
100
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
Source: Reuters EcoWin
2
26/10/2010
What is price stability?
• Means a low and stable positive rate of inflation
• E.g. Inflation in the range of 1-3%
1 3%
• Where inflation has little impact on the day to day
decisions of consumers and businesses
• "The lesson of the past fifty years is that, when
inflation becomes embedded, the cost of getting it
back down again is a prolonged period of sluggish
output and high unemployment
unemployment. Price stability –
returning inflation to the target – is a precondition for
sustained growth."
Source: Mervyn King, Governor of the Bank of England, Mansion House speech, June 2008
The Consumer Price Index
• Consumer Price Inflation (CPI)
– The consumer price index (CPI) is a
standardized weighted measure of price
inflation used to compare the inflation
performance of countries inside the European
Union
– CPI is now used for the inflation target
– CPI excludes mortgage interest payments
payments,
estate agents’ fees and the local authority
council tax
– Calculate inflation using a geometric average
rather than an arithmetic average
3
26/10/2010
Weighted price indices
• Weights reflect the relative importance of household
spending
g on different g
goods and services
• A Family Expenditure Survey is used to track
spending levels on a basket of products
• Aim – find spending patterns of an average family
• Prices checked each month - It collects 180,000
separate price quotations in 150 areas of the UK
• Weightings are periodically reviewed
• As are the products included in the CPI or RPI
basket
• Heavily-weighted items thus have more impact on
changes in the average cost of living
Selected Weights in the UK Consumer Price Index
Total weights for the CPI = 1000. Source: Office of National Statistics
CPI weights
140
140
130
130
120
110
100
100
90
1996=100
120
Housing, water and fuels
110
90
Foods
80
80
70
70
60
60
Clothing and footwear
50
50
40
40
Alcohol, tobacco and narcotics
30
30
20
20
Education
10
10
0
0
01
02
03
04
05
06
07
08
09
10
Source: UK Statistics Commission
4
26/10/2010
Not included in the CPI in 2010!
• Decaffeinated tea, decaffeinated instant coffee, herbal tea
bags, Fair trade tea and coffee, cocoa, double strength
squash premium soft drinks
squash,
drinks, sparkling mineral water
water, canned
cider, soup pouches, chilled pizza instead of frozen pizza,
fresh pasta, tortilla wraps, fresh noodles, tinned sardines, fresh
prawns and crab sticks, garlic, sweet potatoes, beans and
pulses, cherry and vine tomatoes, office chairs, tattoos, ear
piercings, eyebrow waxing, hand-car washing, ladies' socks,
nicotine patches, windscreen repairs, trampoline, Imax cinema
tickets,, comedyy clubs,, coffee table books,, teenage
g fiction
books, foreign newspapers, bread makers, blenders, car airconditioning, white gold, adhesives, small motorised garden
tools, iPhone applications, net books, Blackberries and marina
fees.
Consumer Price Inflation for the UK
Percent
The consumer
price
(CPI)Price Index
Annual percentage
changeindex
in the Consumer
5.5
5.5
5.0
5.0
4.5
4.5
40
4.0
40
4.0
3.5
3.5
3.0
3.0
2.5
2.5
CPI Inflation target = 2%
2.0
2.0
1.5
1.5
10
1.0
10
1.0
0.5
0.5
0.0
0.0
00
01
02
03
04
05
06
07
08
09
10
Source: UK Statistics Commission
5
26/10/2010
UK CPI Inflation for Goods and Services
Looking behind
the CPI
figures
Annual Percentage
Change,
source: ONS
6
5
6
Inflation in Services
5
4
4
Percent
3
2
3
Goods and Services Together
2
1
1
0
0
-1
-2
-1
Inflation in Goods
-2
-3
-3
00
01
02
03
04
05
06
07
08
09
10
Source: Reuters EcoWin
Limitations of consumer price index
• The CPI is not fully representative
– It will be inaccurate for the ‘non-typical’ household
– Whose spending patterns differ from the official weights
– The ‘housing’ category of the CPI records changes in the
costs of rents, property and insurance, repairs. It accounts
for around 16% of the index. Housing costs vary greatly
from person to person
– It does not reflect regional differences
• The Changing
g g Quality
y of Goods and Services
– Although the price of a good or service may rise, this may
be accompanied by an improvement in quality as the
good is updated reflecting improvements in dynamic
efficiency in the market-place
– CPI is slow to respond to the emergence of new products
and services.
6
26/10/2010
Impact of inflation
Google launches a price index!
Google is using its
vast database of web
shopping data to
construct the ‘Google
Google
Price Index’ – a daily
measure of inflation
that could one day
provide an alternative
to official statistics.
7
26/10/2010
Changing Relative Prices for Goods and Services
Retail Price Index, January 1988 = 100
Changing
relative prices
450
450
400
400
350
350
Cigarettes
Index
300
300
Rail fares
Repairs
250
250
200
200
All goods and services
150
150
Cl thi
Clothing
and
d footwear
f t
100
100
Electrical appliances
50
50
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Source: Monthly Digest and Statistics
UK inflation is more stable if we exclude food, fags, booze and energy
Percent
Annual percentage change in consumer prices
6
Volatile components of CPI inflation
6
5
5
4
4
3
3
All items CPI
2
2
1
1
CPI excluding energy, food, alcohol and tobacco
0
0
-1
-1
00
01
02
03
04
05
06
07
08
09
10
Source: Reuters EcoWin
8
26/10/2010
Retail Price and Consumer Price Inflation in the UK
Annual percentage change in the retail price index and CPI
CPI / RPI Comparison
6
6
5
5
Percent
All items retail price index (RPI)
4
4
3
3
2
2
1
1
Consumer price index
0
0
-1
-1
-2
-2
98
99
00
01
02
03
04
05
06
07
08
09
10
Source: UK Statistics Commission
The Inflation Target
• Article 11 of the Bank of England Act
to
• Sets the objectives for monetary policy as "to
maintain price stability" and
• "subject to that, to support the economic policy of
Her Majesty's Government, including its objectives
for growth and employment."
• The target, set by the Chancellor of the Exchequer
is currently 2
2.0%
0% for the consumer price index
• The Governor of the Bank of England must write a
letter to the Chancellor if inflation deviates by more
than 1 percentage point from the target
9
26/10/2010
Reasons for having an inflation
target
• Macro-economic stability should lead to higher levels of capital
investment and economic growth in the future
• Gains from an explicit inflation target:
• Improved accountability of monetary policy – the general
public can see for themselves whether the target is being
achieved
• Credible target lowers expectations of inflation – helps to
control the growth of wages (the inflation target is an “anchor”)
• Can help to improve the trade-off between inflation and
unemployment
• Lower expectations of inflation help to lower long term interest
rates – makes it easier for companies and governments to
borrow
Inflation Expectations
Bank of England/NOP, how do you expect prices to change over the next 12 months?
Percent
6.0
Inflation expectations in the UK
6.0
5.0
5.0
4.0
4.0
3.0
3.0
2.0
2.0
1.0
1.0
0.0
0.0
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1
04
05
06
07
How do you expect prices to change over the next 12 months?
How has prices changed over the past 12 months?
Q3
08
Q1
Q3
09
Q1
10
Source: Bank of England
10
26/10/2010
Inflation Data from the Guardian
Some Inflation Web Resources
11
26/10/2010
tutor2u Economics
Keep up‐to‐date with economics, resources, quizzes and worksheets for your economics course. Join our Facebook Fan Page
12
26/10/2010
Revision Workshops
13