VIDEO: Just what is the CPI anyway? And how does it affect the price of TAKEAWAY

So just what is the CPI and how is calculated?

The CPI is simply a basket of goods and services which tracks the rise and fall of multiple prices in an economy. It takes the average rise of all the things in the basket and that is number we hear reported every month.

The BoE is set a two per cent CPI target (at all times) by the government, which means the BoE is charged with deliberately trying to make that basket of prices RISE by 2% every year.

Said another way, the BoE is deliberately trying to make the value of the pound in your pocket FALL by two per cent every year.

So just how is the CPI calculated today - and is it actually any good at capturing what is happening to prices in the economy?

The most important thing to note about the CPI is that the way it is calculated is changing all the time. For example the types of goods and/or services included in the ‘basket’, and the weighting these items are given, is constantly being tinkered with.

For example, in 2009 rosé wine and takeaway chicken were added to the basket, whereas volume bottled cider and boxes of wine were removed.

This constant tinkering makes it very hard to compare the CPI rate today with say the CPI rate from 10 years ago. Essentially it is not measuring the same thing, meaning a 2% CPI rate today is vastly different from a two per cent rate 10 years ago.

In fact, if we were to use the methodology for calculating this basket of goods the way we did in the 80s, we would find that the CPI is in fact running around seven per cent - not the 1.5 per cent the government tells us...

So changing the methodology and formula for the CPI can produce vastly different results.

Then there are two little known adjustments that are made to the CPI, substitution and hedonic adjustments.

Substitution is where an item in the basket, let’s say chicken, goes up in price beyond a pre-determined threshold. So the bureaucrats at the Office for National Stats who calculate the CPI simple say that people won’t buy chicken at these prices and instead will by turkey or pork (who’s prices haven’t gone up).

And when the official CPI numbers are published, that rise in the price of chicken will simply be left out of the calculation, and that rise in the cost of chicken will not be captured by the CPI.

Then there is something called hedonic adjustments. Let’s say Apple release their new all singing all dancing Ipad - which costs twice as much as the older version. The ONS looks at this and says that the new version is twice as fast, so it’s twice as good, and hedonically adjust the price rise to ZERO.

So while YOU will see the price of an IPAD rise 100%, in the eyes of the government the cost of an IPAD has remained exactly the same.

In just about ALL cases of this constant tinkering with the calculation of the CPI, it makes it look as if prices are rising slower than they really are. And when you look at what payments are linked to the CPI rate, we can see just why there is such a vested interested in keeping the rate low.

There are nearly 10m pensioners in the UK all claiming the state pension. The rate at which the pension rises each year is linked to the CPI rate, so the difference between a 2% rate and a three per cent rate adds up to billions of ‘savings’ for the government.

In fact, this has just happened. Osbourne back in 2010 switched to using the CPI rather than the Retail Price Index to ‘uprate’ pensions - The RPI is just another basket of goods used to calculate prices rises, but the RPI is calculated differently and consistently comes in higher than the CPI.

This switch means that pensioners will lose around £6bn from their pension pot each and every year, and in total nearly 18 per cent less money over the average retirement.

So as you can see, how these numbers are generated are very important - and generating a ‘low’ CPI number is very helpful in getting the government to balance the books - but not so helpful if you’re a pensioner trying to get by on £113 per week.

The main problem with the CPI is that it is impossible to come up with a generic basket of goods that reflects price rises for an entire nation. After all we all have our unique CPI rate, because we all buy different things when we shop.

We’ve become so accustomed to prices rising, we now just see this as a part of life. But what is really happening is the purchasing power of our money is being deliberately eroded as part of government policy year-in, year-out.

So if it feels like your experiencing prices rising much faster than the official 1.5 per cent rate - it is because YOUR personal CPI IS rising much faster than that - Begging the question just how useful is the CPI anyway?