Definition: Inflation rate is the percentage at which a currency is devalued during a period. This is devaluation is evident in the fact that the consumer price index (CPI) increases during this period. In other words, it’s a rate at which the currency is being devalued causing the general prices of consumer goods it increase relative to change in currency value.
What Does Inflation Rate Mean?
Inflation can be caused by many different events and circumstances, but the most common is an increase in the money supply. As a floating currency is becomes more abundant, it’s value starts to decline. This makes sense because it isn’t as scarce as it once was. The inflation rate attempts to measure the change in the currency value over time by comparing a list of standard products called the consumer price index. These products; like milk, bread, and gas; are grouped together and their prices are tracked over time. An increase in these products’ prices over time shows that the money used to buy these products is not worth as much as it used to be.
The inflation rate is the rate at which money loses it value compared with the group of products.
Let’s look at an example.
Joan is an economist at the Bureau of Labor Statistics and she wants to calculate the inflation rate for the next two years. She collects the data for the base year (the current year), year one, and year two as follows:
Joan estimates the total annual cost for each good or service. Then, she sums up to calculate the total annual consumption. The total consumption for the base year, year one, and year two are $10,160, $10,455, and $10,704, respectively.
Joan then calculates the price index per year by dividing the total consumption of each year by the price of the products in the base year. She then multiplies the answer by 100.
Therefore, the price index is:
$10,455 / $10,160 x 100 = 102.9 in year 1
$10,704 / $10,160 x 100 = 105.4 in year 2
Then, Joan calculates the inflation rate for year 1 and for year 2 by calculating the change in the price index. The inflation rate is 2.9% in year 1 and 2.4% in year 2.