Why the price indexes miscalculate the cost of modern life

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The cost of living rose at an annual rate of 2.2 percent in January if you believe the government's Consumer Price Index (CPI).

This is the rate newspapers and TV report and on which the Bank of England bases interest rate policy. But it is fiction as far as reflecting the rising prices faced by working class households.

For a start, the CPI excludes mortgage payments and council tax. A second official inflation measure, the retail price index excluding mortgage interest payments (RPIX), also ignores such costs but hit 3.4 percent in January. This is sometimes referred to as the underlying rate of inflation, presumably because it is closer to the truth.

Add in housing costs and you have a third rate - the Retail Price Index (RPI)-that was 4.1 percent in January.

Why the three measures? The RPI was the traditional measure of inflation in Britain until the Tories dropped it in favour of the RPIX in 1992 and Labour then switched to the CPI in 2003. The CPI has been the calculation method across the eurozone since 1997, where it is known as the Harmonised Index of Consumer Prices (HICP).

This is the rate the government and the Bank of England pledged to keep below 3 percent. Its constant repetition is the biggest reason why the inflation statistics bear so little relation to your experience when shopping.

Ministers hope workers will align wage claims with this rate.

Obviously, the RPI is a better guide for pay negotiation. But what it tells is far from the whole story.

Both the CPI and RPI are published monthly by the Office for National Statistics (ONS) and are based on the cost of about 650 goods and services. The contents vary over time as habits of consumption change. Varying weights are attached to items such as bread, shoes or TVs to reflect the level of spending on them.

The ONS concedes that a difference in the method of calculation means the CPI is always lower than the RPI. There is also an assumption in CPI calculations that when the price of a commodity rises people buy less of it. This might be reasonable in regard to leather sofas, but not for potatoes or tea.

There is obviously a class bias in these rates. The price of champagne has been included in the CPI since 2006, when chocolate biscuits were excluded, and more weight has been given to electrical goods, travel and leisure. This has a distorting effect - personal computers, flat-screen TVs and MP3 players typically fall in price and lower the inflation rate, masking rises elsewhere.

So while the CPI figures for 2007 estimated transport costs up by 5.8 percent and food by 5.4 percent, TVs fell in price by 14 percent, PCs by 25 percent and cameras by 32 percent. The inclusion of air travel has a similar effect, as half of Britain's population does not board an aircraft in any year.

Obviously, those with less money spend a disproportionate amount on housing, food, energy, transport and - if they have growing children - clothes. The falling price of champagne, leather sofas or flights to Marrakech makes little difference when a report by analysts Ernst and Young suggests that 78 percent of the typical household's monthly income goes on essential bills - and many spend more than this.

Power firm E.ON raised gas bills by 15 percent and electricity prices by 10 percent in February, following similar increases by rival companies - none of them included in the most recent inflation figures. Rail fares rose an average 4.8 percent in January, petrol is above £1 a litre and food inflation is at 6.6 percent - with milk, cheese and eggs 15.4 percent more expensive than a year ago.

In the circumstances, best ignore Bank of England governor Mervyn King, when he urges acceptance of lower living standards, arguing that "[inflation] is not something we can offset by demanding higher wages".

Look to the boardroom instead, where a Guardian survey found that pay rose 37 percent last year.