CPI is not the same as inflation. Inflation is the change in CPI over a period of time. It can be calculated as [CP1 Year 1 - CPI Year 2]/CPI Year 2, where Year 1 is greater than Year 2. Using the example above the inflation rate from 1984 to 2009 would be 95%. That’s (195-100)/100.

Using CPI is not necessarily an indicator of the specific inflation rate for any given consumer since the goods and services you buy might not be included in the basket. Instead, CPI and the inflation rate is an approximate cost for the country as a whole.

Monetary inflation happens when the money total in circulation increases faster than the amount of goods in circulation. The government is the only entity who can do this. In the old days, they would simply produce more cash. Today, the government purchases securities from banks, thereby increasing the money supply.

Inflation can possibly lead to deflation. In theory, people would spend less money when prices are rising, but that is not always what occurs. In practice, people spend the money now because they believe the prices will be higher in the future. If they don’t have the cash for wanted purchases, then they borrow it.

Another disadvantage to inflation is that it puts some goods and services out of reach for consumers. Rarely do wages increase the same rate as inflation, so consumers have less cash to spend. As the gap between income and costs closes, so does spending. That situation could eventually lead to deflation.

Typically, deflation is when the average price of goods falls. When the inflation rate drops below zero, indicating negative inflation, we know that there has been deflation. Remember that the inflation rate is calculated based on the change in the Consumer Price Index, or CPI.

Inflation and deflation are both parts of a normal functioning economy. They typically happen in cycles and can correct themselves without any government intervention. However, in extreme situations, like the Great Depression, the economy does need a helping hand from the Feds.

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However as a result of the global credit crunch, banks are starting to hoard money instead of lending which is putting downward pressure on house prices and pushing the monetary policy committee (MPC) towards actually cutting the base rate. Even in this atmosphere of falling house prices, would-be buyers are finding it hard to secure a home loan to make a purchase they can now afford.

The credit squeeze has created much uncertainty in the economy and the nine MPC members seem very reluctant to actually cut interest rates. The members are facing a dilemma in that domestic inflation is heading in one direction while at the same time the international money market is actually going in the opposite direction.

When the Consumer Prices Index went up by 2.1% – which is above the government target of 2% – it would, under any other circumstances, signal an increase in interest rates in order to bring about higher borrowing costs. The interest rate at 5% is still an expansionary rate which will only fuel higher inflation, putting inflation up again to a more neutral level will hopefully neither dampen nor stoke the economy.

However the credit crunch is pulling for interest rates to come down. Uncertainty in the banking sector has prompted banks to cut lending to other institutions and instead hoard cash. Customers are reporting difficulty in securing personal loans, especially for debt consolidation, as lenders are either unable to access the funds, or simply unwilling.

Bank of England governor Mervyn King has warned the MPC that the credit crunch could get even worse in the coming year unless interest rates are cut.

The growing concern over the state of the economy is making many people more unwilling to overstretch themselves by buying a new home now. New figures published by the Halifax have shown that house prices fell by their sharpest rate in more than fifteen years in May.

Many buyers were hoping for a fall in borrowing costs when the Bank of England dropped the base rate to 5%. However, lenders have been unable to pass on the cut as the Libor rate remains high and liquidity low. Loans of all types have been affected.

The Bank of England is due to announce its latest interest rate today and is widely tipped to leave the rate at 5%. Consumers may feel this is a blow, but with the Government worried about inflation, the Bank is unlikely to cut the rate again yet.

Halifax’s chief economist, Martin Ellis, said: “The decline in prices is caused by the difficulties created for potential house purchasers by the rapid rise in house prices in the last few years, a squeeze on spending power and the reduction in credit availability,”

Halifax warn that house prices could continue to drop next year. This is potentially good news for those waiting to afford their first home, but may still not be enough to counteract the credit crunch.

Britons have seen their wages rise 4% in the past year, a stark contrast to the 9% rise in fuel prices seen and the 7% increase in food costs.

Sadly for many, property rental prices have also been increasing as more buy-to-let investors pull out of the market, leaving a diminishing pool of properties available for rent.

Right now inflation is low, so debt is pretty much remaining at the same proportion of your income over time. You see if there was high inflation then you could rely on inflationary increases in your income but that’s not going to happen any time soon. Also the government has removed the tax incentive to hang onto your debt in the form of mortgage tax relief.

So lets break it down. Imagine you have a 25 year home loan at £100,000 and interest rates are at 6 percent. Overpaying on that mortgage by say £100 a month could save you as much as £27,000 and cut the life of your loan by as much as six years. That mean you can take that tropical cruise you have always wanted much earlier with plenty of money to finance it.

A word of caution however, some lenders out there charge what is known as an Early Redemption Penalty. These charges can continue for several years after you have paid back the mortgage. In a situation like this it may not be so wise to pay back your mortgage early. Sometimes you just can’t beat the banks.

Economists are warning that banks and building societies are going to have to raise rates as a result of the current global credit crunch.

This is primarily a result of banks’ reluctance to bring down the rates they charge when lending between themselves. This has caused the cost of financing mortgages by banks to dramatically increase and if the reluctance of banks to bring down rates for inter-bank lending persists we could see these costs coming through the system and hitting borrowers.

Despite all this, banks are also at war in an attempt to attract new customers and recent adverts by some banks are claiming to be cutting the cost of fixed rate home loans.

Banks right now are extremely exposed to bad loan debt in the US and as long as this crisis persists the more likely the chance that eventually this will start to filter through to customers.

It is possible that if the credit crunch persists for much longer, mortgage and loan rates could start to go up. Banks are increasingly turning towards savers as a way of freeing up credit and even though the Bank of England put interest rate rises on hold, some banks are increasing fixed term savings rates.

If banks continue to have difficulty funding mortgages we could well see mortgage rates going up in the near future.

There is a growing consensus amongst economists that interest rates have now peaked. This prediction was further strengthened with a comment the BoE recently released.

One of the biggest reasons the rate rises have had such a large impact is that bank to bank lending is at its highest level in almost a decade. The amount of bank to bank lending depends on the rate banks charge each other for lending which now stands at 6.88%.

This financial turbulence is beginning to be felt by households also result out for the last quarter show that house price inflation was down to 1.6%. The cost of borrowing has gone up considerably in recent months, putting many of us off looking for a new home. Anyone struggling with their home loan repayments should be relieved to hear news that interest rates are not going up again.

Despite the high interest rates, inflation is expected to persist in all areas of the economy. The poor weather last summer meant that harvests were down, which explains the price increase for many goods in your local super market. With fuel costs also at their highest ever rates, it’s no wonder that households are having to borrow money to make ends meet.

While inflation in the housing sector has come down in recent months, house prices are not expected to start falling because of a general shortage of housing across the country and strong employment figures.  

Up until 8 months ago it appeared as if the house price boom would never end with over a decade of record breaking growth in house prices.

However more recent figures coming out in the past two months paint a gloomier picture. If you are a mortgage holder then this could be a cause of great concern as you may end up owing more on your home loan than the value of your house: i.e., negative equity.

Meanwhile the US has seen a decade of growth starting to turn and house prices in many areas of the US are falling as the global credit crunch takes its first victims. Right now in the US there is a record number of mortgage defaults and this is going to start having an effect on us here in the UK as the cost of borrowing goes up.

The Royal Institution of Chartered Surveyors (Rics) has said that nearly half of its surveyors saw price falls in December, the worst figures since late 1992.

Interest rate rises and a tightening of lending criteria are thought to be the main causes of the market drop, with lenders reporting a drop in loan approvals.

The Halifax and Nationwide also reported seeing a weakening of the property market, and recent Government data from

“The housing market is clearly feeling the pinch from the credit crunch and the round of interest rate hikes in 2007,” said Rics spokesman Ian Perry.