What is Inflation and Why does it matter?

Inflation in the UK has been at its highest level since the 1970s, with prices rising by 9% a year.

The Bank of England has raised its inflation forecast for the fifth time in seven months. This time, the prediction is that inflation will hit 11% this autumn when energy bills rise.

The Monetary Policy Committee of the Bank of England has warned that inflation is likely to peak at “slightly above 11% in October” before falling next year, with the price of food and fuel putting pressure on household budgets.

But with inflation on course to rise even further, it will be a long time before it reaches the 2% target that the Bank of England’s mandated.

How does inflation measure?

Inflation is the rate of price increase over a given period. Inflation is typically a broad measure, such as the overall price increase or the cost of living in a country. While in the UK, the government agency that measures inflation is the Office for National Statistics (ONS). The ONS uses the prices of 700 everyday items known as the “basket of goods” to calculate inflation. The BBC reported that the basket of goods is constantly updated, with items such as tinned beans and sports bras added in 2022, reflecting the rising interest in plant-based diets and exercise. The price of that basket of goods and services—known as the Consumer Prices Index, or CPI—explains the overall price level. The Consumer Price Index (CPI) is used to determine the inflation rate. The CPI is calculated by comparing the price of a basket of goods and services on a given date to its price on that same date last year. The change in the price level over time is the rate of inflation.

The reason why inflation is high now?

Britain’s official inflation rate hit a 40-year high of 9% in April, and many experts predict it will surpass 11% in 2022. According to the Bank of England, it is due to a number of factors, including the rising cost of goods.

According to ITV, the UK has struggled with rising prices on runways because of an influx of external shocks. Prices have increased because economies worldwide are still recovering from the Covid-19 pandemic, pushing the price of products, especially goods from abroad. The war between Russia and Ukraine also dramatically impacts the economy. It leads to a significant increase in the price of energy and food. Also, the lockdowns in China, that pursuing a policy of Zero-Covid means a harder importation of goods in the UK. The Bank of England is concerned that the UK will generate inflation domestically. Companies are raising their prices, and workers are asking for higher wages; these increases lead to higher costs in the service sector. However, not everyone is seeing an increase in their pay packet. Wages for regular workers have fallen over the past year. The ONS found that annual growth in regular pay dropped by 4.5% in April after adjusting for inflation – the most significant drop since comparable records began in 2001.

What can be done about inflation?

The “Goldilocks and the Three Bears” analogy—which compares low inflation to porridge and high inflation to too much honey on pancakes—can help us understand why inflation matters. Economic growth will be “cold” and slow if inflation remains too low. Too high and prices will rise rapidly, causing a recession or depression.

However, because much of the UK’s current inflation is caused by external factors—like rising global energy prices—the broadcaster noted that there is a limit on how effective UK interest rate rises can be in curbing inflation.

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