Inflation is measured by the Retail Price Index (RPI). This is like a huge shopping trolley which government inspectors take round the shops every month. They fill it with a representative sample of all the goods and services that people typically buy. Then they add up the prices and compare them with the previous month’s prices. Although figures are collected monthly, they are normally quoted annually eg inflation is 2% pa which means average prices are rising by 2% every year.

Inflation is given as an index number. This means the first year’s calculation is set at 100, and every year after is measured in relation to that. So if 1990 = 100, and 2000 = 110, we know instantly that prices have risen 10% over the 10 years. This is just a way of making the data quicker to understand.

The RPI isn't the only measure of inflation. There is also RPI(X) which excludes mortgage repayments, and RPI(Y) which excludes indirect taxes (VAT and duties such as fuel duty).

The RPI is a good measurement but not 100% accurate, so it is possible sometimes that the government under- or over-reacts to inflation data.

The most common and most well-known measure of inflation is the change in the consumer price index - the CPI. This measure is calculated and published every month by Statistics Sweden (SCB). Each month, SCB “buys” a basket of goods and services. By purchasing the same goods and services, it becomes possible to study the size of the changes in the price of the basket. Since the quality of the goods can change over time, such as when a computer’s performance improves over time, SCB attempts to estimate the value of these improvements and exclude them from the price increases.



The prices included in the basket and the significance of the different price changes depend on how much of the various goods and services households buy. A product or service that is consumed on a large scale is given a greater weight than one that is consumed on a lesser scale. This means that price changes on a product or service that is consumed on a large scale have a greater impact on the CPI than price changes on a product or service consumed on a lesser scale.

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The U.S. Government measures inflation by identifying goods and services that represent the economy and then determines a price for the “basket”. The resulting price of the basket is represented by an index known as the Consumer Price Index for All Urban Consumers1 (CPI). It then compares the price of the basket over time in order to measure the movement of prices. The basket contains 200 categories arranged into eight expenditure categories, which include food and beverage, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. Taxes that are directly associated with the specific goods are also included.

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"It's evident that with 3.5 percent inflation in Europe we should be worried and this is what has made us, since June, not cut interest rates when other banks have been cutting interest rates. We consider reducing inflation is the priority," the Spanish central bank head told reporters at a Madrid conference.

The ECB would have to continue to focus on inflation for it to fall below 2 percent -- the bank's target is just below 2 percent -- in 2009, he said.

Ordonez's comments follow statements by his Governing Council colleagues Axel Weber and Yves Mersch, who dismissed the prospect of any rate cuts this year.

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Inflation is usually estimated by calculating the inflation rate of a price index, usually the Consumer Price Index.[24] The Consumer Price Index measures prices of a selection of goods and services purchased by a "typical consumer".[25] The inflation rate is the percentage rate of change of a price index over time.

For instance, in January 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the course of 2007 is

\left(\frac{211.080-202.416}{202.416}\right)\times100=4.28%

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general level of prices for typical U.S. consumers rose by approximately four percent in 2007.

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GDP deflator is the other major price index used to measure inflation. This is a price index that shows how much of the change in the GDP from a base year is reliant on changes in the price level.

Whereas the CPI tracks variations in prices of listed commodities, the GDP deflator uses a flexible basket of goods that depends on the quantities of goods and services produced in a given year.

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Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year.

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How is inflation measured? It's a good question, considering prices for all goods and services do not increase at the same rate and the same time. This is the challenge faced by economists as they try to describe what is happening to the economy and consumer purchasing power.
Inflation is measured through two indexes, each of which represents of a group of prices. One index measures how pricing is affecting consumers, or buyers. The other index measures how pricing is affecting producers, or suppliers and vendors. The two indexes are as follows:
CPI: Consumer Price Index
The CPI is the index that measures prices that are of concern to consumers. This index is made up of thousands of specifically selected prices of goods and services. Economists labored to select the right goods and services to be included in these numbers. Each month the US Bureau of Labor Statistics collects information on prices from thousands of companies, and these numbers are combined to create the index for that month. This number represents how inflation is affecting consumers.

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Inflation is measured by observing the changes in prices of goods in the economy using econometric techniques. The rises in prices of the various goods are combined to give a price index that reflects the change in prices of these many goods, where the inflation rate is the rate of increase in this index. There is no single true measure of inflation, because the value of inflation will depend on the weight given to each good in the index

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