Briefing: How is inflation measured?

There are numerous measures of inflation which seek to describe the extent to which prices have risen over a period of time. The most commonly cited are the Retail Prices Index (RPI) and the Consumer Prices Index (CPI).

The Office for National Statistics (ONS), which has responsibility for measuring price inflation, calculates the RPI and CPI in broadly similar ways.

Both are based on the rise in prices for a specific range of goods and services, and both rely on data collected by researchers who visit a large number of shops and other outlets to check prices and ensure that the figures used in calculating RPI and CPI are representative.

In all, ONS researchers collect around 650,000 prices on 650 items from around 150 locations. There are regular reviews of the outlets monitored by ONS to ensure that the data is accurate.

In drawing up its "basket" of goods and services, the ONS seeks to ensure that the items selected are representative of consumer spending patterns. It therefore updates the basket every year as shopping habits change.

In 2008, for example, pure fruit smoothies were introduced to represent a changing market in soft drinks, peppers were added to increase the number and range of fresh vegetables included, and computer memory sticks were added to reflect the growing sales of digital memory devices.

In the same year, microwave ovens were removed from the calculation to reflect the fact that falling prices were reducing the proportion of people's spend on this type of item, and CD singles were dropped as people switched to digital music downloads.

Having selected what it considers to be a representative range of goods and services, the ONS then assigns a weight to each item in the basket, representing the proportion of spending that typically goes on each.

In the current year, food and no-alcoholic drinks represent 10% of the total value of the basket, alcohol and tobacco makes up 4.2%, and recreation and culture a total of 15.2%.

By weighting the items in the basket, the ONS can ensure that when items rise (or fall) in price at different rates, this can be reflected in the overall inflation rate. This was especially important, for example, during summer 2008 when food and fuel prices soared ahead of other items.

Finally, having selected items for the basket, weighted them and collected price information, the ONS is in a position to calculate the percentage change in prices from one date to the next.

So what is the difference between the RPI and CPI?

Traditionally, those involved in setting pay (either from a management or union perspective) have used the Retail Prices Index. Data in this series has been published monthly since 1947. It is also used for uprating pensions, benefits and index-linked gilts.

However, the government prefers to use the Consumer Prices Index for macroeconomic purposes. Importantly, the measure allows consistent comparisons with other European countries. Data for this measure goes back to 1997.

The principal differences between the two are that:

• RPI includes housing costs such as mortgage interest payments and council tax which are excluded from CPI;
• CPI includes some financial services charges, such as stockbrokers' fees, which are excluded from RPI;
• RPI excludes the top 4% of households and around 20% of pensioner households (those getting three-quarters or more of their income from state pension or benefits); and
• CPI weightings come from information on household spending in the National Accounts, while RPI weightings are based on the ONS Expenditure and Food Survey.

Finally, it is worth noting that every household has its own inflation rate which reflects where family members shop and the types of items they buy.

The ONS calculates that, in the year to April 2008, the headline rate of RPI stood at 4.5%, but that a typical family with two adults and two children had experienced inflation of 4.3% while a single pensioner whose income came largely from state pension and benefits had had inflation of 5.1%.

Further reading
CPI and RPI: the 2008 basket of goods and services (PDF format) explains the selection of items for inflation baskets and lists all items for the current year. The article first appeared in the Economic and Labour Market Review (ONS) in April 2008.

Measuring UK Inflation (PDF format) explains how and why the ONS publishes inflation measures. . The article first appeared in the Economic and Labour Market Review (ONS) in September 2008.