A basket of several hundred goods and services, reweighted annually, priced in shops each month
The mechanics of the consumer prices index; items are added and dropped to track changing habits
General knowledge · Economics & society
Inflation
UK target set at 2 per cent on the CPI since December 2003
Economics — the price level, its measurement and its runaway forms
A sustained rise in the general level of prices, and so a fall in what a unit of money will buy. It is measured by tracking the cost of a representative basket of goods and services, and most rich-country central banks are now given an explicit numerical target for it — two per cent in Britain and the euro area. Economists agree that sustained high rates are associated with rapid growth in the money supply, and disagree a great deal about the short run, where supply shocks, wage bargaining, expectations and slack in the labour market all have their advocates. Its extreme form, hyperinflation, has destroyed currencies from Weimar Germany to post-war Hungary.
How to spot them
- ▸A basket of goods, reweighted each year, and the letters CPI, RPI or CPIH
- ▸A two per cent target, and a Governor obliged to write a letter if the rate misses it by more than one percentage point
- ▸Wheelbarrows of banknotes, a hundred-trillion-dollar note, or a currency reissued under a new name
- ▸The uncomfortable combination with high unemployment, named in the House of Commons in 1965
Key facts
The UK target was set at 2 per cent on the consumer prices measure in December 2003, replacing a 2.5 per cent target on a different index (2003)
The previous target was 2.5 per cent on RPIX, the retail prices index excluding mortgage interest
If the rate misses by more than one percentage point in either direction, the Governor must write an open letter to the Chancellor
A feature of the UK regime since 1997; letters were written repeatedly through 2022 and 2023
Hungary in 1946, where prices doubled roughly every fifteen hours and a hundred quintillion pengő note was printed (1946)
The worst episode ever recorded; the forint replaced the pengő in August 1946
Germany in 1923, ended by a new currency notionally backed by mortgages on land and industry (1923)
The Rentenmark; by November 1923 one US dollar bought over four trillion marks
Iain Macleod's 1965 Commons coinage for prices rising while the economy stagnates (1965)
'Stagflation' — the condition that dominated the 1970s and broke the postwar consensus
Zimbabwe abandoned its own currency in 2009 after printing a hundred-trillion-dollar note (2009)
The economy dollarised; a new Zimbabwe currency has been attempted several times since
MV = PY, the identity that becomes a theory once velocity and output are assumed stable
The quantity theory of money, the oldest formal account of the phenomenon
Key ideas
- Disinflation is a fall in the rate of increase; deflation is an actual fall in prices. Deflation is generally feared more, because it raises the real burden of debt and encourages people to postpone spending.
- Phillip Cagan's working definition of hyperinflation is a monthly rate above 50 per cent — roughly a doubling of prices every two months.
- The costs usually listed are menu costs, shoe-leather costs, distortion of the tax system, and arbitrary redistribution from creditors to debtors and from those on fixed incomes.
- Expectations matter because wage and price setters build them in. This is why central banks talk so much about keeping expectations 'anchored'.
Quick-fire facts
- •The Bank of England's target is 2 per cent on the CPI, set by the Chancellor; it has been on that basis since December 2003
- •The Retail Prices Index lost its status as a UK National Statistic in 2013 because of a known bias in its formula, but it is still used in index-linked gilts and some contracts
- •UK inflation peaked in 1975 at around 25 per cent — 24.2 per cent for the year as a whole, and close to 27 per cent at its monthly high
- •UK CPI inflation peaked at 11.1 per cent in October 2022, the highest for about 41 years
- •The worst hyperinflation on record was Hungary's in 1945–46, with prices doubling roughly every 15 hours
- •Weimar Germany's 1923 hyperinflation was ended by the introduction of the Rentenmark in November of that year
- •'Stagflation' was coined by the Conservative MP Iain Macleod in the House of Commons in 1965
- •The Fisher equation gives the real interest rate as approximately the nominal rate minus the inflation rate, and is named after Irving Fisher
- •Seigniorage is the profit a government makes by issuing money, and is the mechanism by which printing money finances spending
- •The euro area's target was reformulated in 2021 as a symmetric 2 per cent, replacing the earlier 'below, but close to, 2 per cent'
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Sources
- Bank of England — Inflation and the 2 per cent target The Bank's account of the target, the open-letter rule and the MPC's remit; cited without URL.
- House of Commons Library — Inflation in the UK: Economic indicators