In this section
What Is Inflation?  |  What Causes Inflation?  |  What Is Monetary Policy For?  |  Why Do We Want Stable Prices?  |  How Do Interest Rates Affect Inflation?

the inflation rate
price indices
changes in the inflation rate

Inflation is a general rise in prices across the economy. This is distinct from a rise in the price of a particular good or service. Individual prices rise and fall all the time in a market economy, reflecting consumer choices and preferences, and changing costs.

inflation is a general rise in prices across the economy

If the price of one item - say a particular model of car - increases because demand for it is high, we do not think of this as inflation. Inflation occurs when most prices are rising by some degree across the whole economy.

the inflation rate        

We often hear about the rate of inflation being 2.0% or 2.7% or some other number. The inflation rate is a measure of the average change in prices across the economy over a specified period, most commonly 12 months - the annual rate of inflation. We typically hear about the annual inflation rate for a particular month. If, say, the annual rate of inflation in January this year was 3%, then prices overall would be 3% higher than in January last year. So a typical basket of goods and services costing, say, £100 last January would cost £103 this January.

price indices         

There are a number of different measures of inflation in use today. The most familiar measure in the UK is the Retail Prices Index (RPI). But monetary policy is now based on the Consumer Prices Index (CPI). Both measure the prices of products and services that consumers buy. A price index is made up of the prices of hundreds of goods and services - from basic items like bread to new products, such as PCs. Prices are sampled up and down the country every month; in supermarkets, petrol stations, travel agents, insurance companies and many other places. All these prices are combined together to produce an overall index of prices.

the inflation rate is a measure of the change in prices over a specified period

The goods and services included in the index are chosen and weighted on the basis of the spending patterns of UK households - for example, if gas bills account for around 1% of consumers' total spending, then gas prices will account for about 1% of the index. The percentage weights are revised annually to reflect changes in spending patterns. Sometimes new goods and services are added and sometimes they are taken out. A few years ago, men's cardigans were removed - not many men wear cardigans these days!

Until December 2003, UK monetary policy was based on a measure of inflation called RPIX. RPIX inflation is almost the same as RPI inflation but it excludes one component - namely mortgage interest payments.

But on 10 December 2003 the Chancellor of the Exchequer announced that in future monetary policy would be based on a new measure of inflation - the Consumer Prices Index. This is explained under the heading 'The current inflation target' in 'Policy Framework'. More information and data on the measures of inflation are provided in other sections.

changes in the inflation rate         

Any individual price change could cause the measured rate of inflation to change, particularly if it is large or if the item has a significant weight in the price index. But we are more interested in the general increase in prices rather than individual price changes. A large rise in the price of petrol, for example, might affect the overall rate of inflation. But unless this price carried on rising, the annual rate of inflation would eventually fall back again - the example in the box below explains this, if you want to know more.

Events affecting a range of prices can also result in a change in the inflation rate. For example, a rise (or fall) in oil prices might affect the price of other goods if producers pass on the increase (or decrease). But, again, unless the oil price continues to rise (or fall), this influence on the inflation rate will eventually wear off after a time.

A change in price
If petrol prices had been 50p a litre for some time and then they increased in, say, February 2009 to £1 a litre while no other prices changed, the annual rate of consumer price inflation would increase. If petrol prices remained unchanged after that, the annual rate of inflation would then fall back in the following February 2010. That is because the annual rate of inflation in say February 2010 measures the change in prices between February 2009 and February 2010, during which time the price in our example has stayed the same at £1 a litre - the rise in petrol prices recorded in February 2009 drops out of the calculation. So, although the price of petrol remains at the higher level, annual inflation is not higher after a year or more.

Similarly, if the value of the pound falls against other currencies - ie the exchange rate depreciates - the price in the shops of some imported goods might rise. But only if the exchange rate keeps falling will this influence on inflation continue.

Price changes like those described can have other indirect effects on inflation. But individual price changes in themselves do not have a lasting impact on the inflation rate.

The rate of inflation in a particular month will depend on movements in all prices. But we need to distinguish between individual price changes - which might change the measured rate of inflation for a period - and the notion of inflation as an ongoing, general increase in prices.

©2000-2010 Bank of England.