The Historical Trend

Inflation Rate

The most noted feature of this graph is the double spike of inflation during the 1970s, reaching one spike of about 12 percent in the early 1970s, then after declining during the 1973-75 contraction, hit an even higher peak of 14 percent in 1980. The 1970s is notable as the decade of stagflation, simultaneous high rates of both inflation and unemployment.

Another, perhaps less obvious but also important, feature of this graph is the declining inflation during the expansion of the mid 1980s and through much of the 1990s expansion. Rather than inflation rising during expansions, inflation actually declined. The 1980s decline was likely due, as much as anything, to a reversal of the factors causing the stagflation of the 1970s (energy prices, government regulations) while the 1990s decline was likely attributable to technology-induced economic growth.

A Simple Formula

inflation rate

=

index for period 2 - index for period 1 index for period 1

x 100

Crunching the Numbers

inflation rate

=

155 - 150 150

x 100

=

3.3 percent

A more recent realistic calculation can be done for 2003 using the CPI. The CPI was 179.9 in 2002 and 184.0 in 2003. Plugging these numbers into the formula gives 184.0 minus 179.9 divided by 179.9. In percentage terms this is a 2.3 percent inflation rate, as illustrated here:

inflation rate

=

184.0 - 179.9 179.9

x 100

=

2.3 percent

Annualized Numbers

inflation rate

=

index for period 2 - index for period 1 index for period 1

x 100 x periods per year

To illustrate, consider that the CPI for June of 2003 is 183.7 and for July of 2003 it is 183.9. Inserting this values into the formula gives:

inflation rate

=

183.9 - 183.7 183.7

x 100 x 12

=

1.3 percent

The ACTUAL percentage change from June 2003 to July 2003, the ACTUAL inflation rate, is 0.109 percent. This, however, is the percentage change in the price level from one month to the next. Because people are accustomed to working with ANNUAL changes in the price level, it is more convenient to convert this monthly inflation rate to an annualized inflation rate. This is accomplished when 0.109 percent is multiplied by 12, the number of months per year. This step produces the 1.3 percent inflation rate noted in the calculation.

Care should be taken when interpreting the inflation rate calculated in this manner. The inflation rate is NOT 1.3 percent for July 2003. The price level did NOT increase by 1.3 percent from June 2003 to July 2003. The correct interpretation is that the inflation rate would be 1.3 percent if the price level increased at the same pace for 12 MONTHS as it did from June 2003 to July 2003. Of course, the price level might actually rise at a faster or slower pace than that between June and July, meaning the ACTUAL inflation rate for the 12-month period might be more or less than 1.3 percent.