Consumer Price Indices

Consumer price indices (CPI) are weighted averages of the prices of the goods and services that consumers buy. The weight attached to any item is determined by how much of that item a ‘typical’ consumer bought in some given period: the greater the volume of an item the consumer bought the greater the weight it receives in the index. The weights are fixed for some time but subject to revision as new patterns of consumption become established.

Harmonised CPIs are the result of the European Union’s attempt to derive a CPI series for each country that is based on a consistent coverage and methodology.

Several Central Banks now gear their monetary policy to achieving a particular target for inflation. The rationale for this is that monetary policy (or aggregate demand policy in general) ultimately affects the level of prices even though in the short-run it can affect output and employment. And since the timing of any effects on output and employment are difficult to predict and probably transitory it is more sensible to assign to monetary policy a target that it can reliably attain.

For example, the Bank of England’s monetary policy is geared to hitting an inflation target of 2% expressed in terms of an annual rate of inflation based on the Consumer Prices Index. Their website states that:

The remit is not to achieve the lowest possible inflation rate. Inflation below the target of 2% is judged to be just as bad as inflation above the target. The inflation target is therefore symmetrical. If the target is missed by more than 1 percentage point on either side – i.e. if the annual rate of CPI inflation is more than 3% or less than 1% – the Governor of the Bank must write an open letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the Bank proposes to do to ensure inflation comes back to the target.