Aims In this section various uses of the RPI and CPI are discussed.
The RPI and CPI are intended to help measure price changes. How they are used to do this is discussed in the audiotape band which follows.
Now listen to the audio clip below, called ‘Using the price indices?.
Interactive content appears here. Please visit the website to use it.View documentTranscriptSome calculations use the RPI instead of the CPI.
You have just seen that the RPI can be used as a way of updating the value of a pension to take account of general increases in prices. The RPI is used in other similar ways, for instance to update the levels of some other state benefits and investments. But the CPI could be used for these purposes.
Why are there two different indices? Let's look at how this arose. As well as its use for index-linking, which is basically to compensate for price changes, until recently the RPI played an important role in the management of the UK economy generally. The Government sets targets for the rate of inflation, and the Bank of England Monetary Policy Committee adjusts interest rates to try to achieve these targets. Until the end of 2003, these inflation targets were based on the RPI, or to be precise, on another price index called RPIX which is similar to the RPI but omits owner-occupiers' mortgage interest payments from the calculations. There are good economic reasons for this omission, to do with the fact that in many ways the purchase of a house has the character of a long-term investment, unlike the purchase of a bag of potatoes or even a PC. From 2004, the inflation targets have instead been set in terms of the CPI. The CPI is calculated in a way that matches similar inflation measures in the other countries of the European Union (so it can be used for international comparisons).
In terms of general principles, though, and also in terms of most of the details of how the indices are calculated, the differences between the RPI and CPI are not actually very great. As mentioned in Section 5, the CPI reflects the spending of a wider population than the RPI. Partly because of this, there are certain items (e.g. university accommodation fees) that are included in the CPI but not the RPI. There are also certain items that are included in the RPI but not the CPI, notably some owner-occupiers' housing costs such as mortgage interest payments and house building insurance. Finally, the CPI uses a different method than the RPI does for the very first stage of combining individual price measurements, before the use of averages weighted by expenditure comes into play.
Because of these differences, inflation as measured by the CPI tends usually to be rather lower than that measured by the RPI. In the audio session, you saw that the annual inflation rate in January 2005 as measured by the CPI was 1.6%. The annual inflation rate in the same month, as measured by the RPI, was 3.2%. The annual rate of inflation as measured by RPIX (like the RPI but omitting mortgage interest rates) was 2.1%—less than the RPI rate, but not as small as the CPI rate, showing that the difference between RPI and CPI was not entirely due to the omission of mortgage interest rates from the CPI.
The RPI continues to be calculated and published, and to be used to index-link payments such as pensions. Because there are reasons why the RPI is more appropriate than the CPI for such purposes, it seems likely to continue in use for a long time.
You might be asking yourself which is the ‘correct? measure of inflation -RPI, CPI, RPIX, or something else entirely. There is no such thing as a single ‘correct? measure. Different measures are appropriate for different purposes. That's why it is important to understand just what is being measured and how.
At the beginning of Section 5, you were asked to write down what you thought the RPI and/or CPI were and how they might be used to measure inflation. Now that you have read quite a lot about these price indices and their uses, look back at what you wrote then and make any necessary modification. Write a brief description in your own words of what the RPI and CPI measure; what is meant by the annual rate of inflation, and how it is calculated; what an index-linked pension and the purchasing power of the pound are, and how they are calculated.
There is no comment for this activity.
In this section, you have seen how price rises are measured using an index of retail prices. Earnings are discussed in another Unit. Only when prices and earnings have both been considered can you begin to answer the central question of these two Units: ‘Are people getting better off?? In the final section, you will see how to use a price index in conjunction with an index of earnings to see whether rises in earnings are keeping pace with rises in prices. Before turning to earnings, however, you'll review some of the mathematical ideas that you have met in this Unit.
After studying this section, you should be able to:
♦ use the CPI or RPI to calculate the annual rate of inflation (Frames 5 and 6);
♦ use the RPI to calculate the value of an index-linked pension (Frames 8 and 9);
♦ use the RPI to calculate the purchasing power of the pound at one date compared with another (Frame 12);
♦ explain to someone else what is meant by the CPI, RPI, inflation, an index-linked pension and the purchasing power of the pound. (Activity 29).
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