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Government charges, the CPI and monetary policy

Sharon McCaw

Conceptually, inflation is best understood as on-going erosion of the purchasing power of money. Consumer price inflation is generally measured as changes in the weighted average of the money prices of a basket of selected goods and services. This raises questions concerning the choice of goods and services which constitute that basket, what sort of price changes should be counted as part of the general ‘inflation process’, and whether all price changes should be viewed in the same way, irrespective of why they have occurred. One question that arises in this regard is how prices which are set or considerably influenced by the government should be taken into account. Are movements in these prices part of the inflation process that monetary policy should be concerned with, or should they be viewed differently? The following article suggests that what matters for monetary policy is not so much whether it is the government that is the source of the price level disturbance. Rather, the key considerations are the size of the price shock, the sharpness of the monetary policy adjustment that would be required to offset it, and the implications for inflation expectations. In this sense, price level disturbances caused by changes to government-set prices and charges are not fundamentally different from those that originate elsewhere; for example, from foreign price shocks.