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Inflation, Deflation, CPI and RPI

Inflation occurs when too much money enters the economy and effectively dilutes the value of existing money, with the result that more money is required to purchase goods – prices go up. If too much money is put into circulation then hyper-inflation can occur, which happened in Weimar Germany and more recently in Zimbabwe, where recently inflation was running at something like 1 million percent. If we continue to print money through so-called “quantitative easing”, hyperinflation could happen here. The alleged economic experts know this could happen, so their motives for pursuing this policy must be questioned. One theory is that they are deliberately trying to precipitate a “financial perfect storm” which will utterly destroy the value of the currency and lead to hyper-inflation, this will then allow the bankers to step in with a solution, and we either switch to the euro, or better still a global (single) currency, which dovetails nicely with one World government, such as the IMF Special Drawing Rights (SDR).

In times of inflation savers see a reduction in the value of their savings. Those with debts see a reduction in the cost of their debts.

For consumers, there is no so thing as good inflation, pure and simple it means prices go up, things get more expensive.  To our government and economists of a certain persuasion “Keynesians” inflation is a good thing. The Bank of England (BoE) has set a target of inflation at 2%, most believe this is the maximum the BoE want inflation to reach, its actually the minimum. They want prices to increase by at least 2% per annum, and this would have the added effect of compounding each year. Until recently our inflation has been running at something like 4%, possibly higher, because they don’t report the true rate of inflation accurately, they actually fudge the figures, they lie. They use a number of statistical tools to bring changes into a tolerable range. The tools include:

  • Hedonic Quality Modelling, which lowers reported prices to account for changes deemed to be quality improvements. If new cars have airbags and new computers are faster, statisticians shave a bit from their actual prices to reflect the perception that they offer more for the money than previous versions.
  • Substitution, in which index components that are rising too quickly are replaced with things that are not. In other words, if steak is rising, government statisticians replace it with chicken on the assumption that this is how consumers operate in the real world.
  • Geometric Weighting, in which rising components are given less relative weight.
  • Home Owners’ Equivalent Rent, which replaces what it actually costs to buy a house with an estimate of what homeowners would have to pay to rent their homes – adjusted hedonically for quality improvements. When home prices are rising faster than rents, as they have been for the past couple of decades, this change lowers the impact of housing on inflation.

Today, after three decades of statistical massaging, the Consumer Price Index (CPI) no longer measures the cost of maintaining a constant standard of living. Instead, it measures the cost of a declining standard of living in which consumers are constantly assumed to switch from their first choice to their second or third choices among life’s necessities. Meanwhile, because Social Security payments and many other pensions and wage agreements are tied to the CPI, this deliberate understatement of official inflation lowers the real incomes of participants in these programs – in most cases without their knowledge or understanding.

Another benefit to having inflation is that it reduces the cost of debt, if you increase the amount of money in circulation it reduces the cost of servicing your debt, with governments massively in debt, this means they follow monetary policies including doses of inflation.

The table below shows the effect of inflation on a one pound coin worth £1 in 1971. By 1982 that one pound coin was worth only 25 pence, in 11 years it had lost 75% of its value. By 2013 the real spending power of a one pound coin compared to 1971 was only 6 pence.

1971 £1.00 1981 0.27 1994 0.14
1972 0.94 1982 0.25 1996 0.14
1973 0.86 1983 0.24 1999 0.12
1974 0.74 1984 0.23 2007 0.10
1975 0.59 1985 0.21 2008 0.09
1976 0.51 1986 0.21 2009 0.09
1977 0.44 1987 0.20 2010 0.08
1978 0.41 1988 0.19 2011 0.08
1979 0.36 1989 0.18 2012 0.07
1980 0.30 1992 0.15 2013 0.06

So inflation is a destruction of spending power over time. In real terms in early 2015 we are worse off than we were 40 years ago, due to the erosion of spending power. A worker receiving a wage increase in line with inflation is only standing still in real terms, anything less than the rate of inflation and he is worth off. If you have no pay rise for 5 years and the annual inflation rate is 4% per annum, you are in real terms 20% worse off. You earn no more money but most things you buy will have increased in price.

Deflation is a decrease in the general price of goods and services; technically it is a reduction in the amount of money entering the economy. It is generally understood that there is good deflation (price deflation) and bad deflation (debt deflation).

Price deflation is good for consumers and the people because it means the things we buy get cheaper, our cost of living decreases; who doesn’t think that is a good thing? From June 2014 to early 2015 the price of crude oil dropped by about 60%, and consequently fuel prices at the pumps dropped, and the reported inflation rate was dropping very close to 0%, almost into official deflation territory – so much for the BoE target 2% inflation. A reduction in fuel costs should translate into a reduction of transport costs, which should reduce the price of consumer goods. In markets or economies that are not manipulated (ours are) the natural state is mild deflation, a gradual reduction in prices and the cost of living. The only items we regularly see reduce in price are electrical goods, which start out expensive (Plasma, LED, LCD TV’s, Computers, DVD Players) and reduce rapidly in price as manufacturing costs are reduced and the technologies are improved. With price deflation, the money we have would increase in spending power. If we have deflation (anything below 0%) even if you receive no wage increase, you will be better off.

Debt deflation is bad for government because it increases the cost of servicing their gigantic debt, so that means any deflation is bad and must be avoided at all costs – literally.

RPI and CPI

In the UK, the Retail Price Index (RPI) is a measure of inflation published monthly by the Office for National Statistics. It measures the change in the cost of a basket of retail goods and services.

RPI was first calculated for June 1947.  It was once the principal official measure of inflation. Although it has been superseded in that regard by the Consumer Price Index (CPI), it is still regularly quoted by the UK news media.

The RPI is still used by the government as a base for various purposes, such as the amounts payable on index-linked securities including index-linked gilts, and social housing rent increases. Many employers also use it as a starting point in wage negotiation. It is no longer used by the government as the basis for the indexation of the pensions of its former employees.

In March 2009, the change in RPI measured over a 12-month period turned negative, indicating an overall annual reduction in prices, for the first time since 1960. The change in RPI in the 12 months ending in April 2009, at -1.2%, was the lowest since records began in 1948.

 Housing associations lobbied the government to allow them to freeze rents at current levels rather than reduce them in line with the RPI, but the Treasury concluded that rents should follow RPI down as far as -2%, leading to savings in housing benefit.

In February 2011, the RPI jumped to 5.1% putting pressure on the Bank of England to raise interest rates despite disappointing projected GDP growth of only 1.6% in 2011. The September 2011 figure of 5.6%, the highest for twenty years, was described by the Daily Telegraph as “shockingly bad”

The United Kingdom RPI is constructed as follows:

  1. A base year or starting point is chosen. This becomes the standard against which price changes are measured.
  2. A list of items bought by an average family is drawn up. This is facilitated by the Living Costs and Food Survey.
  3. A set of weights are calculated, showing the relative importance of the items in the average family budget – the greater the share of the average household bill, the greater the weight.
  4. The price of each item is multiplied by the weight, adjusting the item’s size in proportion to its importance.
  5. The price of each item must be found in both the base year and the year of comparison (or month).

This enables the percentage change to be calculated over the desired time period. In practice the comparison is made over shorter periods, and the weights are frequently reassessed. Detailed information is published on the Office of National Statistics website.

The following items are included in RPI but are not included in the CPI – Council tax, mortgage interest payments, house depreciation, buildings insurance, ground rent, solar PV feed in tariffs and other house purchase cost such as estate agents’ and conveyancing fees.

CPI is usually lower as a result. The UK Government announced in the June 2010 budget that CPI would be used in place of RPI for uprating of state pensions and other benefits with effect from April 2011.

The inflation rate quoted each month is CPI. It is being suggested that RPI should be phased out as a measure of inflation. Each month we have had the bizarre event of an announcement of low and falling inflation (CPI) of something like 1% and on the same day we are told house prices (excluded from CPI) have gone up something like 8% YoY (Year on Year). Why do they not also release the RPI figure which includes mortgages?  To understand the real level of inflation we need to consider the cost of items we buy regularly over time, we can’t rely on official figures because we know they are manipulated. Some items to consider are train and public transport costs, electricity and gas prices, private school fees, university fees.

Stagflation

A condition of slow economic growth and relatively high unemployment – a time of stagnation – accompanied by a rise in prices, or inflation.

Stagflation occurs when the economy isn’t growing but prices are increasing, which is not a good situation for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fuelling sharp inflation in developed countries. For these countries, including the U.S., stagnation increased the inflationary effects.

UK Inflation

How to measure the real rate of inflation? Look at school fees   What is inflation actually running at? Most people will tell you that their personal inflation rate appears to be running way higher than the official CPI numbers, and if you look at the individual prices you pay on a daily basis it …

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