What are inflation and deflation?

Inflation and deflation are terms you hear a lot in the business news – but what are they?  And should you care?

It’s official, the UK economy is experiencing “deflation” for the first time since the 1960s. Should you be concerned? This Be Clever Basics guide should help you understand.

What is inflation?

Inflation is a way of measuring the increase of prices. Using a “shopping basket” of everyday goods, containing anything and everything from bread to cinema tickets, prices are tracked. If the average cost of the basket is more than it was a year ago, the country is seeing inflation.

What is deflation?

Deflation is when the average change in prices of the items in the basket drops below 0%.

How is it measured?

The two main methods are CPI (Consumer Prices Index) and RPI (Retail Prices Index). They have different products in their “basket” and are calculated differently, but the main variation is that RPI also includes things like mortgages and Council Tax.

It’s CPI which is used by the Bank Of England, so that’s the index which is currently showing deflation.

Why are we seeing deflation now?

There are lots of reasons, but falling oil prices and supermarket price wars have had a huge affect on what we pay.

How will deflation affect me?

Paying less for things is a good thing for us in the short term.

The problems occur when people stop buying things in the hope they get even cheaper. With less money flowing through the economy, there’s less for wages. That means frozen salaries, or even job losses if deflation carried on for a long time. Economists don’t think this will happen here in the UK.

You could also see Bank of England interest rates remain low – or possibly even cut. That’s not a bad thing for anyone with a mortgage, but you won’t see decent returns on savings.

This is a great video from The Telegraph that has a little more detail.


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