Understanding how to calculate inflation rate is critical to determining how the purchasing power of consumers will change over time. From investors to businesses, citizens, and the government, inflation impacts the purchasing power of all agents in an economy. Since inflation has a direct impact on currency and global commerce, everyone must be aware of its effects as inflation in one country can swiftly impact the greater global economy.
Taking into consideration price levels, purchasing power, and time, the inflation rate represents the rate of decline of purchasing power for a particular currency. Expressed in percentage terms, inflation indicates a unit of currency purchases less than it could in previous periods of time.
This article will illustrate the inflation rate formula, how to calculate inflation rate step by step, and provide examples on how to apply inflation rate to various scenarios.
Inflation Rate Definition
As an indicator of the decrease in purchasing power of a currency, the inflation rate is defined as the rate of which the value of a currency diminishes and the level at which prices for goods or services rise. Inflation is commonly recorded by the Consumer Price Index (CPI) and the Wholesale Price Index (WPI). Other indexes are used for specific countries as well, such as the Producer Price Index (PPI).
Inflation measures the overall impact of price and purchasing power changes over various goods and services during a certain period of time.
Indexes
The Consumer Price Index (CPI) tracks the prices of goods and services purchased by consumers like businesses and individuals. This index is compiled by the U.S. Bureau of Labor Statistics and can be found here.
The Wholesale Price Index (WPI) tracks the prices of wholesale goods sold or traded in bulk quantities between businesses. This index is compiled by The World Bank and can be found here for the United States economy specifically.
Other indexes used to track inflation exist as well and can be used interchangeably depending on the type or area of inflation being measured. All indexes account for seasonal or cyclical price changes in their calculations of price levels as to accurate identify how much price changes are resultant of inflation.
What Is Inflation Rate
Inflation Rate Formula
The inflation rate over the period of one year is calculated by dividing the result of the final CPI value minus the initial CPI value by the initial CPI value of a given period of time and multiplying the product by 100. This formula yields the inflation rate in percentage terms.
Where:
CPIx+n = CPI value of final period
CPIx = CPI value of initial period
x = initial period
n = number of periods after initial period
Note: CPI values can be substituted by WPI, PPI, or other index values when desired.
How to Calculate Inflation Rate
Calculate Step by Step
- Determine the initial period and final period prices will be measured between.
- Locate the corresponding CPI values for the initial and final periods.
- Subtract the initial CPI value from the final CPI value, and divide by the initial CPI value.
- Multiply the product of Step 3 by 100 to solve for the inflation rate.
Example
An economist is determining the amount of inflation in food prices in U.S. cities from August 2011 to August 2021. The economist wants to determine how much the purchasing power of $1 decreased by calculating how much food prices in U.S. cities increased over this time period.
After obtaining consumption data for urban consumers from the U.S. Bureau of Labor Statistics, the economist determined the following values:
CPI for August 2021: 279.135
CPI for August 2011: 229.554
Since the economist is measuring price levels from the same month in two different years, the periods can be assumed to be annual. Since there are exactly 10 years between August 2021 and August 2011, there are ten periods present here.
In this example, the economist can predict the following values based on this assumption and their data:
Initial period (x): 2011
Periods after Initial Period (n): 10 periods
Final CPI Value (CPIx+n): 279.135
Initial CPI Value (CPIx): 229.554
Given these values, the economist can now populate the inflation rate formula as follows to determine the initial and final CPI periods:
Rate of Inflation = (CPIx+n) – CPIxCPIx
Rate of Inflation = (CPI2011+10) – CPI2011CPI2011
Rate of Inflation = [(CPI2021) – CPI2011CPI2011] x 100
Now that the inflation rate formula has been simplified, the economist can now insert the values obtained for price levels from August 2021 to August 2011 and begin solving as follows:
Rate of Inflation = [(CPI2021) – CPI2011CPI2011] x 100
Rate of Inflation = [279.135- 229.554229.554] x 100
Rate of Inflation = (49.581229.554) x 100
Rate of Inflation = (0.216) x 100
Rate of Inflation = 21.6%
Here we can see that the rate of inflation in food prices in U.S. cities from August 2011 to August 2021 was 21.6%. This value represents both the increase in food prices in U.S. cities and the decreased purchasing power of U.S. dollars for foodstuffs in U.S. cities over the past 10 years.
For individuals determining how the value of their assets may have changed or how much the purchasing power of money has decreased, knowing how to calculate inflation rate like this is critical.
Tips for Calculating Inflation Rate
Tip Number 1:
Inflation represents the decrease in purchasing power of currency and the increase in price levels for certain goods or services. Inflation should not be confused with deflation, which has the opposite impact on purchasing power and price levels. When solving for the inflation rate, if a negative value is returned, this value indicates that deflation occurred as price levels dropped while the purchasing power of currency rose.
Tip Number 2:
The inflation formula can be used to identify inflation over any number of periods. Major indexes track prices at least a decade into the past, while CPI specifically has calculated prices as far in the past as 1913. Using this information, inflation can be determined for any number of periods between as small as a month to as large as over multiple decades. CPI measures the weighted average of prices available for a variety of goods or services over a spectrum of geographic locations within the United States, so the formula is highly customizable in this regard.
Tip Number 3:
Inflation does not always increase at a steady rate and can spike depending on several factors. When calculating for inflation, price level changes over certain periods will reflect this. Outstandingly high rates of inflation therefore do not imply the answer is necessarily incorrect, as inflation at these levels is known as ‘hyperinflation.’ For example, Germany experienced a rate of inflation from August 1922 to November 1923 of over 332%. Similarly, Venezuela experienced a rate of inflation in 2020 alone of approximately 2,355%.
Inflation Rate Takeaways
The inflation rate is the measure of how much the purchasing power of currency decreased and prices of goods or services increased over a certain time period. Inflation rate can be calculated by using data from major price indexes like the CPI, WPI, or PPI and is expressed in percentage terms.
When calculating the inflation rate, negative values imply deflation occurred where purchasing power of currency increased and prices of goods or services decreased. If the rate of inflation is outstandingly high, hyperinflation occurred over the time period measured.
