How Is Inflation Calculated in the UK - PowerPoint Presentation Example

What is Inflation Inflation is the rate at which the price of goods and service may increase. (Davies, A related term is Deflation, which meansthe rate at which te price of goods and services may decrease over a period of time. There are a few ways to measure inflation; the most popular ones are Consumer Price Index (CPI) and Retail Price Index (RPI) (Davies, 2012) Every measure of inflation considers the price of several things we consume or spend money on, for example cold drinks, alcohol, theatre tickets etc. it basically gives us an idea of how and at what rate have the price for these things increased or decreased over a period of time. (Davies, 2012). The Inflation is stated as a percentage. For example if the CPI is 2%, it means that we now have to spend 2% more on the same goods and services than we were doing earlier. Consider the price of a Cinema Ticket. Suppose it was £10 last year and the CPI is 2%, this means we will now have to expend £10.2 for the tickets this year. (2% increase in price) (Davies, 2012) CPI measures the changes in prices for Consumer goods and services only, whereas RPI includes mortgage costs taxes and interest payments. CPI accounts for consumer choice as well. It formulates that with a change in price, a consumer shall move to a cheaper alternative or go for a substitute product. For example, if the price of Tea increases too much for the liking of a consumer, he may opt to consume Coffee if it is available within his price range. The Government and Bank of England use CPI and RPI to fix interest rates, if inflation is expected to rise beyond a certain level, the Government may increase interest rates in order to curb inflation. How is Inflation calculated in UK? The Office of National Statistics (ONS) collects several prices of goods and services. It weighs how much we spend on the relative products every month and then these prices are combined to produce a composite index which is the Rate of Inflation. . In the United Kingdom, the most important categories in the consumer price index are Transport 16.20% Housing Water Energy and Fuels 14.40% Recreation & Culture 13.40% Restaurants & Hotels 11.40% Food and Non-Alcoholic Beverages 11.20% Misc. Goods & Services 9.60% Clothing & Footwear 6.50% Furniture Household Equipment etc. 6.10% Others 11.20% (Office for National Statistics (ONS) (UK), 2014) The Inflation in UK in January 2014 was recorded at 1.9%, with the average Inflation between 1989 till January 2014 being 2.8%. It recorded a High of 8.5% in April 1991 and a low of 0.5% in May 2000. (Taborda, 2104) The following table represents the history of Inflation in UK over the past decade. As we can see from this table, the highest Rate of Inflation was recorded in Sept. 2011 and Sept. 2008 at 5.2%, and the lowest at 1.1% in Oct. 2009 and March April Oct. of 2004. Year jan feb mar apr may jun jul aug sep oct nov dec ann 2014 1.9% 2013 2.7% 2.8% 2.8% 2.4% 2.7% 2.9% 2.8% 2.7% 2.7% 2.2% 2.1% 2% 2.5% 2012 3.6% 3.4% 3.5% 3% 2.8% 2.4% 2.6% 2.5% 2.2% 2.6% 2.6% 2.7% 2.8% 2011 4% 4.3% 4.1% 4.5% 4.5% 4.2% 4.5% 4.5% 5.2% 5% 4.8% 4.2% 4.5% 2010 3.4% 3% 3.4% 3.7% 3.3% 3.2% 3.1% 3.1% 3% 3.1% 3.2% 3.7% 3.3% 2009 3% 3.1% 2.9% 2.3% 2.2% 1.8% 1.7% 1.5% 1.1% 1.5% 1.9% 2.8% 2.2% 2008 2.2% 2.5% 2.4% 3% 3.3% 3.8% 4.4% 4.8% 5.2% 4.5% 4.1% 3.1% 3.6% 2007 2.7% 2.8% 3.1% 2.8% 2.5% 2.4% 1.9% 1.7% 1.7% 2% 2.1% 2.1% 2.3% 2006 1.9% 2.1% 1.8% 2% 2.2% 2.5% 2.4% 2.5% 2.4% 2.5% 2.7% 3% 2.3% 2005 1.6% 1.6% 2% 1.9% 1.9% 1.9% 2.4% 2.3% 2.4% 2.3% 2.1% 1.9% 2% 2004 1.4% 1.3% 1.1% 1.1% 1.4% 1.7% 1.3% 1.3% 1.1% 1.2% 1.4% 1.6% 1.3% (Office for National Statistics (ONS) (UK), 2014) Inflation vs. GDP growth. As we can see from the 2 graphs, controlled inflation is good for the economy. The BOE has set the benchmark for controlled inflation at 2%. At this rate we can see GDP growth consistently. However, if we closely examine the period between 2008 and 2010, we can see the inflation rate rise considerably. This has led to negative GDP growth. So we can infer that controlled inflation boosts the economy as both demand and supply increases. However, with a spiraling inflation, demand and thus output declines resulting in negative economic growth. Controversies Regarding Inflation in UK In April 2011, the Government announced that for the purpose of regulating benefits, public pensions and tax credits, it would use the CPI and not the RPI measure of inflation. This brought a lot of flak to the then government. This will impact thousands of public sector workers. John Amos said that this change will result in pensioners being paid 8.5% lesser of their expected pensions by 2017. Lord Hutton further added that it could cost pensioners over 25% during their lifetime. (Lambert, 2014) Uncontrolled Inflation outside the UK: Germany had a notorious case of galloping inflation in 1923. The prices rocketed to 85,000,000,000% than the previous year. The Government had to issue currency with a highest denomination of 1000,000,000,000 marks. (Taborda, 2104) However, the worst recorded effect of inflation was in 1946, Hungary. The prices of goods and services were doubling every twelve hours. The government issued bank notes of 100,000,000,000,000,000,000 pengo. (Taborda, 2104) Conclusion: Inflation is not a real problem in UK. It is being controlled by the BOE by maintaining low bank rates. BOE has cut back the funding for lending on mortgages, signaling that shutting off the supply of ‘cheap money’ in the economy is a greater concern than raising interest rates. (Taborda, 2104) The logic being that the influx of ‘cheap money’ might result in an inflation which is above 5% and then it will be difficult to bring it down. The Realty Sector and Capital Markets have performed well owing to this move by BOE but that cannot be said for the economy as a whole. However, it is expected that the GDP will grow in the near future and that inflation will be controlled as well and kept in check as per BOEs policies and efforts. Low levels of inflation shall end the rapidly increasing energy costs, which will boost the overall currency exchange of the Pound. This will result in profitable Import Export. Moreover, the current unemployment crisis too may be resolved as a 2% bump in wages may be lucrative enough for Labor and will stop them from demanding increased wages and thus increase overall profitability. (Taborda, 2104) Works Cited Davies, P. (2012, August 17). Inflation Explained. Retrieved March 09, 2014, from BBC (UK): http://www.bbc.com/news/business-12196322 Lambert, S. (2014, February 12). When will interest rates rise? Savers hopes smashed as Bank of England says base rate will only rise slowly and wont return to normal. Retrieved March 09, 2014, from Mail Online: http://www.thisismoney.co.uk/money/news/article-1607881/When-UK-rates-rise.html Office for National Statistics (ONS) (UK). (2014, March 07). Data & Reference Tables. Retrieved March 09, 2014, from ONS: http://www.ons.gov.uk/ons/datasets-and-tables/index.html Taborda, J. (2104, February 18). UK Inflation Rate Below BoE’s Target . Retrieved March 09, 2014, from Trading Economics: http://www.tradingeconomics.com/united-kingdom/inflation-cpi Read More