Inflation is the steady increase in prices and decrease in purchasing power over time. The inflation rate can be calculated using formulas that rely either on the Consumer Price Index (CPI) or Gross Domestic Product (GDP). However, the causes of inflation, and finding the right fiscal policies to manage it, cannot be solved with a formula.
Let’s take a closer look at what the inflation rate is, possible reasons why prices change, and the different ways to calculate the inflation rate.
What Is the Inflation Rate?
Ever notice how things don’t get cheaper over time? Take the cost of bread as an example. The average price of a loaf has steadily risen from around $1.40 in 2013 to $1.94 in 2023. That’s because of inflation, or the increase in the price of goods and services and the decrease in purchasing power over a period of time. This means your dollar may not go as far as it did in the past, though there are ways to protect your money from inflation.
When people talk about inflation rate, they’re referring to a measurement of how much prices have increased over a period of time. Cost increases can vary across product categories, and certain states may be impacted more by inflation.
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What Causes Inflation?
There are a few common causes of inflation. The first is when demand for a product is greater than the supply, which is often referred to as “demand-pull” inflation. This can happen when the government or Federal Reserve adds funds to the money supply or lowers interest rates, often in an attempt to combat higher unemployment and stimulate economic growth. It can also occur when consumers have more disposable income and are more economically stable.
The second main cause of inflation is when the cost of producing a product increases, and as a result, businesses must raise their prices. This is called “cost-push” inflation.
A third common cause of rising prices is “built-in” inflation. That’s when companies give workers a bump in pay to keep up with rising living costs, and then in turn raise the prices of their products to help offset those costs.
When inflation hits, tools like a spending app can help you keep your finances in order.
Recommended: How to Invest During Inflation
What Is the Consumer Price Index?
The Consumer Price Index (CPI) tracks and measures the average change in prices for 80,000 or so commonly purchased goods and services. Those items fall into eight major categories: food and beverage, recreation, apparel, transportation, housing, medical care, education and communication, and various services. Social Security taxes, income taxes, or the purchase of investments are not included.
Each month, the U.S. Bureau of Labor Statistics calculates and publishes the CPI. Economists, policymakers, businesses, and consumers follow the findings closely, as the index is a popular measure of inflation. The data is also used to determine cost-of-living adjustments for federal benefit payments.
How to Use CPI to Calculate the Inflation Rate
If you want to calculate the inflation rate for a certain period, you’ll first need to decide what goods you are going to examine. You can use CPI charts to gather the historical price information for those goods. Keep in mind that the index measures the average of the price of the goods or services over a stretch of time.
You’ll also want to decide what time frame you’d like to examine. Do you want to know the rate of inflation for the past five or 10 years? Or are you estimating the inflation rate for a future period?
Once you’ve collected all your historical price data, organize the information on a spreadsheet. Find the price of your goods at your starting point, and name that price A. Identify the price of your goods at your end point, and name that price B.
Now you can apply the inflation rate formula:
Inflation rate = Price B – Price A / Price A x 100
Your answer is the inflation rate as a percentage.
You can also use the BLS’s CPI Inflation Calculator to see how buying power has changed over the years.
Recommended: 2022 Hourly Wage Inflation Calculator Table
How to Find the Inflation Rate with GDP
Using the CPI is one way to measure changing price levels and inflation. Another way is the Gross Domestic Product (GDP) deflator.
GDP is the sum of the value of all goods and services produced and sold by a country in a specific period of time, usually a quarter or year. It’s considered an indicator of a nation’s economic strength because it shows what is being produced and sold.
Unlike the CPI, the GDP deflator measures the change in prices in the economy as a whole, including goods and services, government spending, and exported goods. It provides a more comprehensive measure of inflation.
To find out how much prices have changed over a period of time, you’ll need two pieces of information: the nominal GDP (the value of goods and services produced at current market prices) and the real GDP (the value of goods and services produced at inflation-adjusted prices). The Bureau of Economic Analysis updates and publishes this information on a quarterly basis.
Here’s the formula you’ll use:
GDP deflator = (Nominal GDP / Real GDP) × 100
The answer is the rate of inflation in terms of GDP.
The Takeaway
From the growing cost of education to rising mortgage rates, inflation can impact consumers on a number of fronts. Inflation commonly occurs when demand for a product outstrips supply, businesses increase their prices to cover rising costs of production, or companies raise their prices to cover cost of living wage increases. The inflation rate measures how much prices have risen over a period of time and is calculated by examining the change in prices of certain consumer goods and services over a period of time. The CPI is generally the metric used to calculate the inflation rate, but some economists prefer to use the GDP deflator because it takes more data into account.
When prices start to rise, it can be a smart idea to keep a closer eye on your finances. A money tracker app can help. The SoFi app connects all of your accounts in one convenient mobile dashboard. From there, you can keep tabs on your balances, spending breakdowns, and credit score monitoring. Plus, you can get other valuable insights.
FAQ
What is inflation?
Inflation is the increase in the prices of goods and services and the decrease in purchasing power over time. This means your dollar will not go as far as it did yesterday.
How do you calculate the inflation rate?
To calculate the inflation rate using the Consumer Price Index, first collect the price data for the period you are studying. Find the price of your goods at the beginning of your period (Price A) and at the end (Price B). Next apply the inflation rate formula, which is Price B – Price A / Price A x 100. Your answer is the inflation rate as a percentage.
What is the current inflation rate?
The U.S. inflation rate was 6.4% for the 12 months ended January 2023, according to the U.S. Department of Labor. In 2022 at the same time, it was 7.5%, and in 2021 it was 1.4%.
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