UK inflation at record low of 0.3%: Why is it important and what does it mean for you?

 

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The Independent Online

Falling fuel prices and supermarket price wars have contributed to the drop in inflation of a record 0.3 per cent low, which in turn is boosting household spending power. But what is low inflation and what are the consequences?

What is inflation?

It is a short-hand term for the rate at which things are getting more expensive in an economy. To measure inflation statisticians first create a representative “basket” of goods and services. This is based on what a typical household would consume (based on surveys). The statisticians regularly go out into the shops and make a note of the prices of these items. This enables them to compile a broad “index” of consumer prices, which tends to rise every year. Consumer Price inflation is the monthly change in this index from its level a year earlier.

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What does record low inflation mean?

That prices are not rising as rapidly as they have been. So imagine if a box of 6 eggs cost £1.25 in February 2014 and today it costs £1.30. The annual rate of inflation for this item would be 4 per cent. But if the eggs today cost only £1.26 the rate of inflation would be just 0.8 per cent. Consumer price inflation in January was just 0.3 per cent, the Office for National Statistics said today. That means prices across the economy have been very subdued relative to recent years. The ONS estimates that inflation on this measure has not been this low since 1960.

What are the consequences?

If people have to spend less of their disposable incomes on essential items such as food, fuel and clothing they should, in theory, have more left over to buy other non-essentials. Many economists think the British public will generally spend this low inflation windfall. And since consumer spending is around 60 per cent of the economy this should make the entire economy grow faster.

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Lower petrol prices have helped to keep a lid on the cost of living

Is low inflation a good thing or bad thing?

As far as near-term economic growth go economists think it is a good thing for the reasons outlined above. But there are negative side-effects too. Inflation tends to erodes the “real” value of people’s debt. This means the nominal value of the sum borrowed and the regular repayments feel less expensive as prices and peoples’ wages rise at a decent rate each year. But when inflation is very low this helpful effect disappears. If people or companies have a lot of debt very low inflation may make them less inclined to spend, which could end up hurting growth in the medium term.

And what about deflation…?

That’s when prices actually start falling. Economists are very wary about this happening and central banks generally want to avoid it becoming a trend. The reason is that if people think items in the shops are going to be cheaper in the future there is a danger that they will stop spending and wait before making purchases. Deflation also means that debts become steadily more difficult to bear. This can set of a downward spiral where the economy contracts, prices fall and people spend less and less. Economic stagnation can be the result – and breaking the downward spiral can be very difficult.

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