Concept and Measurement of Inflation
Inflation is defined as a noticeable rise in the price level of goods and services across a nation in a given period of time. Inflation is measured using the Consumer Price Index (CPI.) This measurement is a calculation of the weighted average of the an average 'basket' of consumer's goods and services. The average changes in these prices is used to calculate the rate of inflation, shown by the formula above.
There are two main types of inflation: headline and underlying.
Headline inflation is a measure of the changes in prices that includes irregularities and anomolies within the economy. This means that unusual or seasonal fluctuations in prices are included in this figure. An example of this occured during the COVID-19 pandemic, when childcare payments was covered by the government, and therefore free for society. This irregularity in the economy would be included from headline inflation calculations. This type gives a more accurate indicator of price changes and is the measure used most often.
Underlying inflation calculates the changes in average prices of consumers’ purchases without including anolomies or irregularieties in economies. Using the same example, when childcare payments were temporalily free, this fluctuation in price was excluded from the final figure. It can be found using either the 'trimmed mean' or 'weighted median' method, used to remove the top and bottom 15% of inflation figures in order to attain an average. For this reason, this type of inflation produces as a very broad measure that is prone to short term fluctuations as well as also demonstrates the price changes of different types of goods which can indicate economic performance.
Graph and Real World Example
As shown by the graph from the Reserve Bank of Australia, the different statistics produced by both types of inflation show many similarities, yet in certain instances, the values produced are very different. This could be due to seasonal influences, such as cyclones destorying crops, or price changes from the COVID-19 pandemic that have shocked the economy. The effects of these shocks would not be included in underlying inflation, yet they would be included in the headline inflation figure, thus producing different results.
Reserve Bank of Australia. 2021. Inflation and its Measurement | Explainer | Education. [online] Available at: .https://www.rba.gov.au/education/resources/explainers/inflation-and-its-measurement.html