How Inflation Impacts Your Spending Power

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Inflation impacts on everyone’s spending power and one of the most important issues in economics.

As the cost of living rises and falls, inflation affects interest rates for mortgages and savings, how much our pensions are worth and the price of everything we buy in the shops.

But few people understand exactly what inflation is and the influence it has on the economy, both at home and worldwide.

What is inflation?

In simple terms, inflation is the rate the cost of goods and services rise in an economy over a specific time, so the annual inflation rate is measured over a year, but sometimes the change is taken month by month or quarterly.

How is inflation measured?

Economists and statisticians set up an index with a base rate on a particular date.

The index will monitor the price of specific goods and services.

The government has two main measures – the Consumer Price Index (CPI) and the Retail Price Index (RPI).

Other indices track house prices, the cost of oil and even the stock market – the FTSE100.

Each follows price changes on ‘baskets’ of goods.

The CPI covers the cost of goods consumers buy, such as train tickets, bread, other foods, pints of beer, car fuel and energy.

Why is the change in inflation a percentage?

A percentage is an easy way to compare prices a year ago with those in the shops today. Inflation is currently around 2.0%, which means prices today are about 2.5% more than a year ago.

That means paying for a loaf of bread in a supermarket a year ago may have been £1, but today the same loaf costs £1.02.

What’s the difference  between the CPI and RPI?

The main difference is the items the index counts to calculate the inflation rate. The RPI includes housing costs, like mortgage payments and council tax, but the CPI does not.

That generally means the rate of inflation measured by the RPI is around 2% more than that recorded by the CPI.

What’s the point of measuring inflation?

Index-linked benefits and pensions are adjusted each year ‘in line with inflation’.

That’s typically the rate at the end of September each year.

The Bank of England also tinkers with interest rates to speed up or slow inflation.

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