The Underlying Rate of Inflation is the rate of inflation measured by a retail price index excluding mortgage interest payments (RPIX). This is contrasted with the ‘headline’ rate of inflation, which in the UK is measured by the retail price index (RPI), including mortgage interest payments. This distinction is peculiar to the UK, as the RPI in most other countries excludes mortgage interest.
Historical Context
The concept of the underlying rate of inflation emerged in response to the volatile nature of interest rates and their impact on the measurement of inflation. By excluding mortgage interest payments, the underlying rate aims to provide a clearer picture of core inflation, unaffected by interest rate fluctuations.
Key Events
- 1980s: Rising interest rates highlighted the need to differentiate between core inflation and total inflation including mortgage costs.
- 1992: The RPIX was formally adopted in the UK to provide a more stable measure of inflation.
- 2003: The UK replaced RPIX with the Consumer Prices Index (CPI) as its main measure of inflation, but RPIX still holds significance for certain economic analyses.
Types/Categories
- Headline Inflation (RPI): Includes mortgage interest payments, reflecting the total cost of living changes.
- Core Inflation (RPIX): Excludes mortgage interest payments, offering a more stable indicator of inflation excluding housing cost volatility.
Detailed Explanations
Mathematical Formulas/Models
RPIX Calculation
The RPIX can be calculated using the formula:
where:
- \( P_i \) = current prices of items excluding mortgage interest
- \( P_{i0} \) = prices of items in the base period
- \( Q_i \) = quantity of each item
Charts and Diagrams
graph TB
A[Headline Inflation (RPI)] -->|Includes Mortgage Interest Payments| B[Mortgage Interest Rates]
C[Core Inflation (RPIX)] -->|Excludes Mortgage Interest Payments| D[Stable Inflation Measure]
A --> E[Total Cost of Living]
C --> F[Core Cost of Living]
Importance and Applicability
The underlying rate of inflation is critical for:
- Economic Policy: Provides a more stable basis for monetary policy decisions.
- Investment Decisions: Helps investors assess real value changes excluding volatile mortgage costs.
- Cost of Living Adjustments: Offers a clearer view for salary and pension adjustments.
Examples
- Economic Analysis: Analysts might use RPIX to gauge real inflation trends unaffected by fluctuating interest rates.
- Government Policy: Policymakers rely on core inflation measures to decide on interest rate adjustments.
Considerations
- Scope: Only applicable in the UK context due to specific RPI definitions.
- Relevance: Less critical in countries using CPI as the main inflation measure.
Related Terms
- Retail Price Index (RPI): An index measuring the change in the cost of a basket of retail goods and services, including mortgage interest payments.
- Consumer Price Index (CPI): A measure of inflation excluding mortgage interest payments, often used internationally.
Comparisons
- RPI vs. RPIX: RPI includes mortgage interest payments and is more volatile, while RPIX excludes them, providing a more stable inflation measure.
Interesting Facts
- Housing Market Impact: Changes in interest rates can significantly skew the headline inflation but have less impact on the underlying rate.
Inspirational Stories
- Government Reforms: In times of high inflation, the UK government’s adoption of RPIX helped stabilize economic policies and guide the country through economic turbulence.
Famous Quotes
“Inflation is taxation without legislation.” — Milton Friedman
Proverbs and Clichés
- “Keep an eye on the real cost.”
Expressions
- “Stripping out the noise of interest rates.”
Jargon
- RPIX: Retail Price Index excluding mortgage interest payments.
- Headline Inflation: Common term for overall inflation including all components.
FAQs
Q: Why does the UK have both RPI and RPIX?
A: The UK differentiates to provide a clearer view of core inflation unaffected by volatile interest rates.
Q: How does RPIX impact economic policies?
A: It offers a stable measure for policymakers to base decisions on, without the distortion of fluctuating mortgage costs.
References
- Office for National Statistics (ONS), UK
- Bank of England publications
- Academic papers on inflation measurement
Summary
The underlying rate of inflation, represented by RPIX in the UK, excludes mortgage interest payments to provide a more stable measure of inflation. This concept is essential for accurate economic analysis, guiding monetary policies, and making informed investment decisions. Although its significance is primarily in the UK, understanding the distinction between RPIX and other inflation measures like RPI and CPI is crucial for economic literacy and effective policy formulation.
