Your own personal CPI

The personal inflation calculator (PIC) introduced by the ONS may do more harm than good. In fact, I wonder if concern over the blizzard of misleading inflation calculations that will feature in every newspaper column and letters page this week may have been one of the triggers for last week's "shock" Bank of England rate rise.

The general public and economists look at inflation in different ways. If it cost £40 to fill up the car last week and £50 this week, most members of the public would see that as inflation. However, economists would see such a price change, other things being equal, as DEflationary. If people have to spend more on fuel, they have less money available o spend on other items. For economists, inflation is a general rise in prices and costs throughout the economy, not just a shift in relative prices. Most economits nowadays would agree that this is only possible if monetary policy is excessively permissive, a view summed up in the late Milton Friedman's dictum that "inflation is always and everywhere a monetary phenomenon".

The official price indices compiled by the ONS -- CPI and the older RPI -- are far from perfect. Ludicrously, CPI takes no account of housing costs. But these measures at least attempt to reflect average spending patterns within the economy. Consider, though, what will happen as members of the public start to play with the PIC. Anyone with a mortgage has certainly seen their cost of living increase over the past few months, as the Bank has raised rates and lenders have pulled back on incentive deals. Electricity and gas bills have soared, and council taxes keep rising. If you just calculate a PIC based on these, the results will be horrific.

In the official indices, these upward pressures are offset by continuing falls in prices for electronics, imported clothing etc. However, most people using the PIC are likely to argue that they don't buy a new laptop or MP3 player or whatever every year, and will therefore exclude such items from the calculation altogether (whereas the ONS carefully calculates their impact on average spending patterns). The popular version of the PIC will be dominated by frequently purchased items, many of which have seen sharp price increases over the past year, and by mortgages.

The Bank of England has plenty of good reasons to be worried about the inflation outlook. Survey data show that companies are more confident about their pricing power than they have been for many years. The Bank's reaction to this is to raise rates to keep underlying inflation pressures in check. However, when they see their PIC calculations the reaction of most people, especially union negotiators, will be to demand a wage increase, which will only make the Bank's job more difficult. Little wonder that the Bank decided to get its retaliation in first.