How best to measure inflation? The UK and Europe

On the 5th October 1990 the then Chancellor of the Exchequer, John Major, announced the Government’s proposal for full British membership of the European Monetary System (EMS), from the following Monday, thereby ending mass speculation about the date of the UK’s application. The belief that the time was now ripe was stimulated by the view that there would be substantial reduction in the UK’s rate of price inflation over the coming year, both in absolute terms and relative to the inflation rates experienced by our European partners. In providing such a justification John Major appeared to have gone back on not only his own word but also that of the previous Chancellor, Nigel Lawson. Both stressed on several occasions that entry into the exchange rate mechanism (ERM) of the EMS would take place when the conditions spelt out in the Madrid summit had been met. The most stringent condition was the UK achievement of the EC average rate of inflation. As recently as the 3rd April 1990, in answering questions before the House of Commons Treasury and Civil Service Committee, Mr Major maintained that, whilst the conditions for entry were moving towards being met, the condition that Britain’s inflation rate should be “proximate” to the European Community level had “certainly not been met”. This important decision is one example of how important is the measurement and presentation of the rate of inflation in determining policy and economic behaviour. It is not the only one - the impact of published inflation figures on the wage bargaining climate has at times been crucial and had far-reaching consequences during the past two or three decades. This article attempts to assess whether the most widely accepted and used definition of inflation (the percentage change in the Retail Price Index (RPI)) is the most appropriate for calculations, starting with some comparisons with our European neighbours.