Prices: keeping a Monster at bay

This week's recession talking point will be deflation.
Figures out later this week will show that one of the key measures of inflation, the Retail Price Index, is heading into negative territory.
In other words, it looks like prices are on a steep downward slope.
The risk of a downward slope is that we end up with deflation, which boils down to a belief among consumers that there's little point buying now because everything will be cheaper next month.
That's enormously damaging to the economy because it turns into a monster that has its own momentum. People wait, prices fall, people wait, prices fall, people wait...until retailers and their suppliers go out of business and people lose their jobs.
So we don't really want to go there for any length of time.
Which is why it pays to understand something about the Retail Price Index (RPI) before we jump to conclusions about deflation.
It's one of two measures used to calculate inflation, the other being the Consumer Price Index (CPI).
Both measure a range of prices, and tot up the effect they have every month on a rolling, 12 month average of price rises. This figure is expressed as a percentage up or down.
There are major differences between the two, though.
CPI is an internationally-agreed measure which the Government and the Bank of England use as their inflation target – this is the figure the Bank tries to influence by moving interest rates up and down (the target is 2%).
It's based on a check taken every month on a basket of everyday goods and services.
The big difference between CPI and RPI is that CPI doesn't include mortgages and house prices.
Right now, that's significant.
Falling house prices and falling interest rates mean these costs have been plummeting like a stone. Which is why the RPI will go negative this week.
The significance of RPI lies in the fact that unions often use it as the basis of pay claims, while councils use it to justify Council Tax rises.
But RPI below zero does NOT mean we are in the grip of the deflation monster. It is essentially telling us what we already know about the housing market.
CPI is the one to watch. Heavy discounting on the High Street means that come summer this, too, will probably be below 1%.
That's why all the Government and the Bank of England have been desperately pumping money into the economy.
They want spending to pick up before Consumer Price Inflation hits the deck. And before that monster takes hold...