Business

Zero inflation: What does it mean?

Street scene from 1973
Image caption High inflation and high fashion in the 1970s

If you can remember the 1970s (I certainly can) zero inflation really is quite a landmark.

Back then inflation was in double figures for most of the decade and was more than 20% for a year.

Curbing price rises was perhaps the major economic priority for the Conservative government that took office at the end of the period.

A quarter of a century on, and here we are with inflation at zero and a very real possibility that it will go lower still.

What does zero inflation mean?

This is how the Office for National Statistics puts it: "A basket of goods and services that cost £100.00 in February 2014 would have still cost £100.00 in February 2015."

To make one obvious point; it is a metaphorical basket. It includes many services, and you can't put a package holiday or a service for the car in a basket.

And it's not any old basket.

Frozen pizza

It's a specific one that is selected to be representative of what an average consumer would buy.

The basket does change to reflect changes in shopping patterns. Items are added or removed.

Image copyright Science Photo Library

For example in this year's basket chilled pizza has replaced frozen pizza.

Items are weighted to reflect how much people spend on them and those weights are changed.

Even so, the basket is very similar to what it was 12 months earlier, so it's near enough right to say something to the effect that the basket cost the same as it did a year ago.

Personal rates

Does that average consumer, who buys the representative basket, actually exist?

Possibly not and it is certainly the case that many people have spending patterns that are different from this average.

It means that your own personal inflation rate might well be lower or higher than the official figure.

One of the main reasons inflation has declined so much in recent months is that petrol prices have fallen sharply.

If you don't have a car, there's a fair chance that your own inflation rate is above zero.

Image copyright PA
Image caption Falling petrol prices helped to drive inflation to zero

If you are an enthusiastic motorist it might be less than zero.

Whatever you spent your money on a year ago might now be cheaper.

How this translates into a standard of living depends on what happens to a person's income, after tax and national insurance have been deducted.

The Office for National Statistics only publishes earnings figures before taxes and they are not as up-to-date as the inflation figures.

Deflationary spiral?

They show average earnings in the three months up to January rising from a year earlier by 1.8% including bonuses, and by 1.6% without them.

Combine that with inflation that is low (though not down to zero at the time when these earnings figures were collected) and you get a rising average standard of living for people in employment.

Image copyright PA
Image caption Inflation is at its lowest level since records began

There are some important factors not reflected in that however: income from self-employment and savings as well as the impact of tax.

In the short term that favourable impact on the standard of living would if anything be even more marked if inflation does go lower still - if we have falling prices overall or deflation.

That can be a real worry if it becomes entrenched as a deflationary spiral.

It can lead to people and businesses delaying spending and it can be bad for those with debts - because company revenue may decline even if their payments don't.

But the Bank of England doesn't expect that risk to materialise in the UK.

It expects inflation will gradually rise back towards the 2% target.

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