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How To Calculate The Inflation Rate (With Examples)

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Summary. To calculate the inflation rate, subtract the past cost of an item from its current cost, and divide that result by the past cost. Your result will be a decimal number, so multiply it by 100 to get a percentage.

Ever wondered why your favorite childhood candy seems to cost way more than you remembered? When you look around, everything costs more than it did when you were a kid. The truth is that the value of money is always changing, and sometimes it will trend toward inflation.

In this article, we’ll explore the nature of the inflation rate and discuss the basic steps for calculating it.

Key Takeaways

Calculate the inflation rate by subtracting the past cost of an item or service from its current price, and dividing that result by the past cost.

The Consumer Price Index (CPI) monitors the average prices of goods and services, making it a valuable tool for calculating inflation.

The inflation rate is important because it can indicate changes in cost of living and overall economic growth.

How to Calculate the Inflation Rate

How to calculate the inflation rate over a period of time, how to calculate inflation rate if it’s more than 100%, examples of calculating inflation, how to calculate inflation rate using gdp, what is the inflation rate, why is the inflation rate important, the consumer price index, what causes inflation, how to calculate the rate of inflation faq, final thoughts.

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Like any other important economic rate, a formula is used to calculate the inflation rate of a nation or region.

Typically, the formula requires a particular starting point, whether that be a year or month in the past. This starting point is taken from the consumer price index for a specific good or service.

Next, the past cost is compared to the current cost of the same good or service. Simply put, the equation uses subtraction to find the difference between the two numbers.

This difference indicates how much the consumer price index for that specific good or service has increased, which will inevitably show increased inflation.

To then calculate the specific inflation rate, those results are divided by the starting price (the past price, rather than the current price). The result of this calculation will be a decimal, which can easily be converted to a percentage by multiplying it by 100.

This percentage will give you the rate of inflation.

Written out, the formula to calculate the inflation rate is:

[(Current CPI – Past CPI) ÷ Past CPI] x 100 = Inflation Rate

[(B – A)/A] x 100 = Inflation Rate

Though calculating the inflation rate for a certain period of time can feel complicated, the customer price index will aid you and help make your work easier. With the right research, you can figure out how to calculate the inflation rate using the specific dates, the CPI, and historical price records.

With those tools in mind, the following steps can be applied to calculate the inflation rate for any given or chosen period of time:

Research. Remember that the CPI represents an average, not specific numbers, so it’s essential to do your own research . Make sure you research the particular items you’re looking to calculate an inflation rate for. After you determine the goods you will be evaluating, gather information on prices during a specific period.

Create a chart with CPI information. Using the averages provided by the CPI, you can create a chart that will show you different CPIs from the past and present. Remember, you make the chart as readable as possible to aid in your work efficiency. Doing this will make it easier to use the formula provided in the previous section.

Choose a time period. You should use your chart to find and choose the date you’re interested in. You can even pick a future date if you choose because you can use the averages and formula to calculate the information across any given number of months, years, or decades.

Locate the CPIs for the past and current dates. On your data chart, locate the CPI for the good or service that will serve as your starting point (a past date). Then, with the same good or service, identify the CPI for the later date. Often, you’ll want to use the current year or month. After you gather these numbers, they will be the ones you plug into the formula.

Plug your numbers into the inflation rate formula. Now that you have your numbers, simply utilize the formula provided. Subtract the past date CPI from the current date CPI and divide your answer by the past date CPI. Afterward, multiply the results by 100 to get a percentage. Your answer will be the inflation rate you’re interested in.

Seeing as the inflation rate indicates an increase in prices, when the average inflation rate reaches 100%, that means the goods and services in question have doubled in price. To help keep information clear, the Bureau of Labor Statistics (BLS) usually selects a new base year when rates escalate over 100%.

However, when you’re doing your own calculations, and the CPI index is over 100%, you can subtract 100 to determine how much prices inflated during that period. Remember that this new number reflects an increase on top of the original price and that the prices have more than doubled.

Coffee Inflation Rate Calculation Example

If Joe bought his morning coffee for $1.25 in 2010, but now he’s paying $1.60 in 2020, he can use this formula to calculate the inflation rate: 1.60 minus 1.25 equals 0.35. Then, dividing .35 by 1.25 equals 0.28. Finally, multiplying 0.28 by 100 equals 28%, so the inflation rate for Joe’s cup of coffee between 2010 and 2020 was 28%.

Gas Inflation Rate Calculation Example

If the CPI shows that a gallon of gas costs $1.06 in 1998 and $2.45 in 2015, we can use these numbers in our formula as well. 2.45 minus 1.06 equals 1.39. Divide 1.39 by 1.06. The results are 1.31. Multiply that by 100. The inflation rate for a gallon of gas more than doubled between 1998 and 2015, as the percentage is over 100 at 131%.

Also known as the GDP deflator, calculating the inflation rate using a country’s GDP is another way to approach it. To calculate the inflation rate using GDP, use the following formula:

Nominal GDP represents an economy’s gross domestic product as evaluated at current market prices. Real GDP is adjusted for inflation and is sometimes referred to as “constant-price” or “inflation-corrected” GDP.

The inflation rate is a quantitative measure of the rate at which the average price level of selected goods and services in an economy will increase over a certain period. As a result of this increase, a larger quantity of currency will be required to purchase said goods.

This measurement is generally expressed as a percentage and will indicate a decrease in the purchasing power of a nation’s currency.

The importance of the inflation rate lies in how it affects the economy. If the average cost of items increases, the currency loses value, and more money is required to acquire the same goods and services as before.

For example, if Tom allocated $500 a month for groceries, but the inflation rate causes the cost of groceries to rise, he would have to increase his grocery budget to afford the same items. In Tom’s case, the inflation rate would compel him to either increase his grocery budget or decrease his groceries’ quantity and/or quality.

That’s why the inflation rate plays a critical role in how you budget your lifestyle and plan for the future. The fact that the value of the dollar fluctuates will impact your cost of living .

Further, regularly keeping an eye on inflation is essential because if there is a steady inflation rate, the adverse effects will lead to slower economic growth.

One of the main ways inflation is monitored is through the consumer price index (CPI). In essence, the CPI is a measure taken from the average of prices from a hypothetical “basket of goods and services” purchased by consumers. After the price changes of each item are taken, they are then averaged to create a fairly reliable CPI.

Remember that the basket of goods and services includes everyday food items such as milk or coffee, which are regularly affected by inflation. However, food items aren’t the only consumables calculated.

The basket of goods and services, and therefore the CPI, also includes other items consumers must purchase, such as:

Transportation

Medical expenses

Inflation affects all of these essentials, too, so you should watch out for increasing prices.

Finally, the reported prices per item are completed by the Bureau of Labor Statistics (BLS) on a monthly basis. Keep an eye on these numbers, as they can suggest price trends for essential goods you need.

Ultimately, changes in CPI are important because they’re used to evaluate these changes in essential expenses. With a quantifiable cost of living, periods of inflation in an economy can be determined.

Inflation is caused by an increase in the supply of money. This can take the form of the Federal Reserve printing more money or, more commonly, by loaning money that doesn’t technically exist as credits through the banking system.

This doesn’t fully explain how inflation happens, though. Economists have broken the phenomenon down to three main drivers:

Cost-push inflation. Cost-push inflation happens when the prices of labor and raw materials increase. The cost of production goes up, so the cost of the final product goes up. In this scenario, the product is just as in-demand as it was before, so manufacturers can safely pass on the added costs of production to consumers.

Cost-push inflation is somewhat predictable, as you can count on workers to demand higher wages as the cost of living goes up and you can expect resources to cost more as they become more scarce.

Demand-pull inflation. Demand-pull inflation relates to prices going up due to the supply of certain goods not being able to keep up with an increase in demand for those goods. As more people have money to afford these products, prices go up.

Built-in inflation. Built-in inflation refers to an almost self-fulfilling prophecy of economics. People intuitively know that things are getting more expensive, and so want higher wages to keep up. Those higher wages in turn drive up the cost of production, which increases your cost of living.

What is the inflation rate formula?

The inflation rate formula is:

What does a 5% inflation rate mean?

A 5% inflation rate means the average cost of certain goods has increased by 5% over a certain period of time. For example, if the inflation rate of the price of gas from 2000 to 2020 is 5%, that means average gas prices increased by 5% over that 20-year span.

What are the three main causes of inflation?

The three main causes of inflation are:

Rising costs of labor and materials.

Increased demand and decreased supply.

Higher wages in response to higher costs of living, which result in higher production costs and product prices, increasing the cost of living.

What is the CPI rate for 2022?

The CPI rate was 6.5% for 2022. This means that on average, prices went up by 6.5% from December 2021 to December 2022.

The inflation rate is often one of the most important topics when discussing the economy and the value of the dollar. After all, money affects every class and every age.

As a consumer who participates in the economic cycle, knowing the basics of inflation is crucial for understanding the best ways to manage your money. If you can plan for the state of the economy, you’ll have more tools for financial success.

U.S. Bureau of Labor Statistics – Consumer Price Index Summary

U.S. Bureau of Labor Statistics – Consumer Price Index

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Jack Flynn is a writer for Zippia. In his professional career he’s written over 100 research papers, articles and blog posts. Some of his most popular published works include his writing about economic terms and research into job classifications. Jack received his BS from Hampshire College.

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How To Solve Inflation Rate Math Problems

Inflation rate math problems can be solved by using the consumer price index formula . The formula is as follows: Inflation rate = (Consumer price index – Base year consumer price index) / Base year consumer price index To solve for the inflation rate, you would need to know the consumer price index for the year in question and the base year. The base year is usually the most recent year for which data is available. Once you have the consumer price index for the year in question and the base year, plug those numbers into the formula and solve for the inflation rate. For example, let’s say the consumer price index for 2019 is 2.0 and the base year is 2018. The inflation rate would be: Inflation rate = (2.0 – 1.0) / 1.0 Inflation rate = 1.0 This means that the inflation rate for 2019 was 1.0%.

Understanding the fundamental factors of inflation is essential in ensuring that you manage your money wisely. In this article, we’ll look at the nature of inflation and how it’s calculated, as well as the steps involved in calculating it. A product’s formula is calculated by using the Consumer Price Index (CPI). By conducting research on the CPI and historical price records, you can determine how to calculate inflation using these two methods. Because CPI is an average, not a specific number, doing your own research is essential. To create a chart, use the CPI averages to compare different CPIs from the past and present. This quantitative measure of inflation is defined as the rate at which the average price level of selected goods and services in an economy increases over a certain time period.

Inflation rates are typically expressed as percentages, and they indicate how much currency is required to purchase goods. Another way to think about inflation is to consider the GDP of the country. Inflation occurs when money supply increases. The CPI ( Consumer Price Index ) is a measure of price trends calculated from an hypothetical basket of goods and services. Inflation affects all of these essential items as well, so keep an eye on prices. Cost-push inflation occurs when the prices of labor and raw materials rise in tandem. Demand-pull inflation occurs when prices rise as a result of a mismatch between supply and demand. In economics, built-in inflation is an almost self-fulfilling prophecy.

Inflation Rate Example

Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling. Central banks attempt to measure and predict inflation, and to control inflation via monetary policy . The most well-known measure of inflation is the consumer price index (CPI), which is the percentage change in prices of a market basket of consumer goods and services.

How To Calculate Inflation Rate Using Cpi

The first step is to subtract the CPI from the beginning date (A) and the later date (B) and divide it by the CPI for the beginning date (A). You can get an inflation rate percentage by multiplying the result by 100.

Because it is an index, the CPI is simply an index value that is indexed to 100 in the base year, as in 1984, in this case. The same market basket is used by the Bureau of Labor Statistics each year. The cost of the market basket for any year can be divided by the cost of the base year, so divide the cost of the market basket by year. According to the graph below, inflation rates between 1984 and 2004 ranged from 2.5% to 4.5%. The 2004 Consumer Price Index (CPI) was calculated using 2004 as a base. In other words, if I pay $106 plus $75, the result will be 28.9 As a result, prices have risen by 28% over the same period. Inflation in 1985 would be 27.5% if the period from 1984 to 1985 had been included. There is a 14 cent increase in gasoline prices over the last 34 years.

How To Calculate Annual Inflation Rate From Monthly

In order to calculate the annual inflation rate from monthly data, you will need to first find the monthly inflation rate . To do this, take the current month’s CPI and divide it by last month’s CPI. Then, multiply this by 100 to get the monthly inflation rate in percent. Finally, to get the annual inflation rate, simply multiply the monthly inflation rate by 12.

Consumer prices are expected to increase by 4.8% over the next year, which means you’ll have to pay more for things like housing and groceries. Inflation is the tendency of prices for goods and services to rise over time, decreasing the value of a currency. Inflation is critical for the entire economy because it affects every aspect. Inflation is defined as the change in the price of goods and services. There are numerous reasons why prices fluctuate, including the printing of the dollar. The Consumer Price Index (CPI) is a widely used inflation index and indicator. It is a component of the Bureau of Labor Statistics in the United States.

The inflation rate formula allows you to calculate how much the cost of goods increased or decreased between the years. It is easier to draft a budget when you understand inflation rates. The letters A and B serve as the starting and ending points for a specific good or service in this formula. The inflation rate is calculated by subtracting the beginning price (A) from the later price (B), then dividing it by the start date (A). To calculate the percent change in inflation, multiply the result by 100. Using the Consumer Price Index (CPI), a base year can be used to calculate inflation rates. Simply label the CPI for the beginning and end dates, A and B, respectively, and insert it into the inflation formula .

Bananas had a rate of inflation of 50 cents per pound in March 2014 as opposed to July 2001 when they had a rate of 50 cents per pound. In comparison to January 2002, the price of gasoline is expected to be $3.03 per gallon in July 2021. You can calculate how much inflation has occurred using the inflation rate formula. For example, you would first subtract 191.083 (A) from 213.023 (B), which yields a 0.1148 inflation rate. To get the percentage, multiply that by 100 by the number of digits. Use the free inflation calculator to determine how inflation is expected to change.

What Is The Cpi-u And Why Is It Important?

The BLS takes into account not only the price of goods sold, but also the cost of services such as rent, utility bills, and medical care when calculating inflation rates. The BLS factors in the cost of services, such as rent, utilities, and medical care, when calculating inflation rates. This methodology is referred to as CPI-U (Consumer Price Index – Unadjusted). Inflation is calculated by the CPI-U in September because it factors in changes in the cost of living, such as rent and medical care, which can vary greatly from month to month and year to year. The cost of living in the United States affects everyone, from the average householder to the investor who buys stocks and bonds. If you understand the rate of inflation, you will be able to make more informed financial decisions.

Inflation Rate

The inflation rate is the rate at which the general level of prices for goods and services in an economy increases over a period of time. The inflation rate is used to calculate the Consumer Price Index (CPI).

In July, the US inflation rate was lower than expected to 8.5% from a high of 9.1% in June, bringing the annual rate down from 8.5% in June. The core inflation rate was unchanged at 5.9%, slightly higher than expectations of 5.7%, and providing some evidence that inflation has reached its peak. According to Trading Economics’ global macro models and analyst expectations, the US%27s inflation rate is expected to reach 8.5% by the end of this quarter. For the long term, a forecast of around 1.90 percent inflation in the United States is expected between now and 2023. The Unadjusted Consumer Price Index for All Urban Consumers is calculated by adding the prices of market basket items, such as food (14 percent of total weight), energy (9.6%), commodities less food and energy commodities (19.4 percent), and services less services (5.5%)

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10.5: Application - Inflation, Purchasing Power, and Rates Of Change

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• Page ID 22128

• Jean-Paul Olivier
• Red River College of Applied Arts, Science, & Technology

How much does inflation cut into people’s incomes and wealth? In 1955, the average Canadian w orker earned an annual gross salary of about $2,963.1 By 2010, the average Canadian worker brought home annual gross earnings approximating $44,366.2 Does this mean that Canadians today are 15 times richer than our grandparents? From earlier discussions in section 4.3 on inflation, real income, and purchasing power, you already can tell we are not. The actual increase is by something less than 15 times. But how much less is it?

To answer the question, you have to express both incomes with reference to the same year. Either convert the 1955 income to its 2010 equivalent or vice versa. To help, what if you are told the rate of inflation from 1955 to 2010 averaged 3.91% 3 per year? To convert, you might use either the percent change method or the real income method. Each of these poses problems, though:

• To use the percent change formula from section 3.1, you would have to apply it 55 consecutive times! Clearly, this is impractical.

• To use the real income formula from section 4.3 , you would need the consumer price index numbers for both years. Locating CPI values can be time consuming, especially for years in the distant past. Another complication is that if you want to project future values (such as the equivalent income in, say, 2020 instead of 2010), CPI values do not exist for future years.

There has to be an easier way! In this section, you will see how to adapt the compound interest concepts and formulas to suit such applications as inflation, purchasing power, and even percent change.

Inflation is the overall upward price movement of products in an economy. It is measured by positive change in the consumer price index. Historical inflation rates in Canada are illustrated in the figure below.

Note that historically prices have always risen over the long term. In the short term, though, there have been periods during which prices moved downward. This is known as deflation , which is measured by negative change in the consumer price index. Such periods of deflation usually do not last very long; the longest period recorded was during the Great Depression. Most recently, deflation occurred for a few months in 2009. Inflation is most commonly expressed as an annua l rate; therefore, you treat it mathematically as an annually compounded interest rate. This is the nominal interest rate (\(IY\)) with a compounding frequency of one, or \(CY\) = 1. Note that if deflation has occurred during the time period in question, the interest rate is a negative number. If you have a series of inflation rates, you treat this as a variable interest rate. If you are finding an average inflation rate for some time period, you treat this like finding the equivalent fixed interest rate. In using the compound interest formulas, assign the present value to any beginning value in the problem at hand, while the future value is any ending value. The number of compounding periods (\(N\)) still reflects the number of compounds between the two values.

How It Works

You can use any of the formulas and techniques from Chapter 9 to work with inflation. The opening example of incomes in 1955 and 2010 will illustrate the processes.

Solving for Future Value

If the unknown variable is an ending value, apply Formula 9.3, solving for the future value. If only one inflation rate (a fixed rate) applies, this requires only one application of the formula. If the inflation rate changes over time, you apply the formula multiple times or use the quick method of calculation:

\[FV=PV \times\left(1+i_{1}\right)^{N_{1}} \times\left(1+i_{2}\right)^{N_{2}} \times \ldots \times\left(1+i_{n}\right)^{N_{n}} \nonumber \]

In the example, you could move the 1955 income to 2010. In this case, the \(PV\) = $2,963, \(IY\) = 3.91%, \(CY\) = 1, and \(N\) = 55. With a fixed interest rate, apply Formula 9.3 and calculate \(FV = $2,963(1 + 0.0391)^{55} = $24,427.87\). Therefore, the 2010 equivalent income of 1955 is approximately $24,427. Note the actual 2010 income is about 81% higher, which would imply that Canadians have indeed become wealthier.

Solving for Present Value

If the unknown variable is a beginning value, apply Formula 9.3, rearranging for present value. Depending on whether the inflation rate is fixed or variable, solve using the same technique as for future value. In the example, you could move the 2010 income to 1955. In this case, the \(FV\) = $44,366, \(IY\) = 3.91%, \(CY\) = 1, and \(N\) = 55. With a fixed interest rate, apply Formula 9.3, rearranging for \(PV\), and calculate \(PV\) = $44,366 ÷ (1 + 0.0391)55 = $5,381.41. Therefore, the 1955 equivalent income of 2010 is approximately $5,381. Note this income is the same percentage (81%) higher than the actual 1955 income, as you found by the first method.

Solving for the Rate

If the average inflation rate is the unknown variable, then the beginning and ending valu es must be known. In the example, assume the average inflation rate is unknown, but the equivalent incomes of \(PV\) =$2,963 in 1955 and \(FV\) = $24,427.87 in 2010 are known. The \(CY\) = 1 and \(N\) = 55 years. Applying Formula 9.3 results in \(\$24,427.87 = \$2,963(1 + i)^{55}\). Solving for \(i\) you get 3.91%. This is the average inflation rate (since \(CY\) = 1, then \(i = IY\)).

Solving for the Term

If the unknown variable is the amount of time between the beginning and ending values, once again apply Formula 9.3 and rearrange for \(N\). In the example, assume the beginning and ending values of \(PV\) = $2,963 in 1955 and \(FV\) = $24,427.87 are known, but the year for the future value is unknown. The \(IY\) = 3.91% and \(CY\) = 1. Applying Formula 9.3 gives you \(\$24,427.87 = $2,963(1 + 0.0391)^N\). Solving for \(N\) gives 55 years. The starting year of 1955 + 55 years is the ending year of 2010, in which the equivalent income of $24,427.87 applies.

Important Notes

Your baii plus calculator.

The time value of money buttons are designed for financial calculations and require you to follow the cash flo w sign convention at all times. Remember that this convention requires money leaving you to be entered as a negative number, and money being received by you to be entered as a positive number.

When you adapt this function to economic calculations such as inflation, no money is being invested or received— numbers are being moved across time. To obey the calculator requirement of the cash flow sign convention, ensure that the signs attached to the present (\(PV\)) and future values (\(FV\)) are opposites. The choice as to which is positive and which is negative is arbitrary and does not affect the outcome of the calculation. Ignore the cash flow sign displayed on any solutions.

Many experts today claim that the average Canadian retiree in 2012 needs approximately $40,000 in gross annual income to retire comfortably. Assume that you are 20 years old in 2012. Historically in Canada, the inflation rate has averaged 3.16%. If the average inflation rate continues in the future, what gross income will you require when you retire at age 65?

Calculate the ending value (\(FV\)) for your annual gross income when you retire at age 65.

What You Already Know

The present value, fixed inflation rate, and time frame are known, as illustrated in the timeline.

How You Will Get There

With a \(CY\) = 1, the \(i = IY\).

Apply Formula 9.2 to calculate the number of compounding periods.

Calculate the future value by applying Formula 9.3.

\(i\) = 3.16%

\(N\) = 1 × 45 = 45

\(FV = \$40,000(1 + 0.0316)^{45} = \$162,207.15\)

When you retire in 2057, if inflation continues to average 3.16% annually, according to the experts your annual gross income must be $162,207.15 for you to live comfortably.

Excel Instructions

Open the Excel template entitled “Chapter 9: Single Payments and Compound Interest Template.”

Purchasing Power

Recall from section 4.3 that the purchasing power of a dollar is the amount of goods and services that can be exchanged for a dollar. Purchasing power has an inverse relationship to inflation. When inflation occurs and prices increase, your purchasing power decreases.

The Formula

In the formula introduced in section 4.3, the denominator used the CPI to represent the change in product prices. In compound interest applications, you instead use the inflation rate, as shown in Formula 10.2.

Formula 10.2

Follow these steps to solve a purchasing power question using compound interest:

Step 1 : Identify the inflation rate (\(IY\)), the compounding on the inflation rate (\(CY\)), and the term (Years). Normally, \(i = IY\) and \(N\) = Years; however, apply Formula 9.1 and Formula 9.2 if you need to calculate \(i\) or \(N\).

Step 2 : Apply Formula 10.2, solving for the purchasing power of a dollar.

Using the income example, determine how an individual's purchasing power has changed from 1955 to 2010. Recall that the average inflation during the period was 3.91% per year.

Step 1 : The \(IY\) = 3.91%, \(CY\) = 1, and Years = 55. The annual rate lets \(i\) = 3.91% and \(N\) = 54.

Step 2 : From Formula 10.2, the \(PPD=\dfrac{\$ 1}{(1+0.0391)^{55}} \times 100=12.1296 \%\). As a rough interpretation, this means that if someone could purchase 100 items with $100 in 1955, that same $100 would only purchase about 12 of the same items in 2010.

Things To Watch Out For

Determine exactly what the question is asking you to calculate with respect to the purchasing power of a dollar.

• If the question asks, "What is the purchasing power of a dollar?" then your answer is the result of Formula 10.2.
• If the questions asks, "How has your purchasing power decreased?" then your answer is 100% minus the result of Formula 10.2.

It is critical to Plan when solving these questions so that your solution addresses the question asked.

Exercise \(\PageIndex{1}\): Give It Some Thought

What is the purchasing power of your dollar if the prices on products:

• 1/3 = \(3.3\bar{3}\%\)

The historical inflation rates in Canada were 3.13% from June 2007 to June 2008, −0.26% from June 2008 to June 2009, and 0.96% from June 2009 to June 2010. Comparing June 2007 to June 2010, what is the purchasing power of a 2007 dollar in 2010?

Calculate the purchasing power of a 2007 dollar (\(PPD\)) in 2010.

The inflation rates and terms are known, as illustrated in the timeline.

\(CY\) (for each time segment) = 1, Term (for each time segment) = 1 Year

Step 1 (continued) :

Identify the periodic interest rate (\(i\)) and the number of compounds (\(N\)) for each time segment. With \(CY\) = 1, then \(i = IY\) and \(N\) = Years.

Apply Formula 10.2, substituting the variable interest rate version in the denominator.

\(i_1\) = 3.13%, \(i_2\) = −0.26%, \(i_3\) = 0.96%; \(N_1, N_2, N_3\) = 1

\[\begin{aligned} PPD &=\dfrac{\$ 1}{(1+0.0313) \times(1-0.0026) \times(1+0.0096)} \times 100 \\ &=96.2933 \% \end{aligned} \nonumber \]

Calculator Instructions

The purchasing power of a June 2007 dollar in June 2010 is 96.2933%. If $100 in June 2007 could purchase 100 items, in June 2010 $100 could only purchase about 96 items.

Rates of Change

Recall from section 3.1 that you could calculate a percent change between Old and New numbers. While this formula works well when you are interested in just a single percent change, it becomes time consuming and tedious when you work with a series of percent changes. For example, assume the \(TSX\) has a value of 12,000. The \(TSX\) then drops by 4% each month for five months, and then rises by 4% each month for five months. What is the “New” value for the \(TSX\)? It is not 12,000! If you use the formula for percent change, you need a series of 10 calculations solving for “New” each time—one calculation for each month! Not much fun. Mathematically, in a series of percent changes, each change compounds on the previous one. Therefore, you can use compound interest formulas to work with any series of percent changes.

You can solve any series of percent changes by applying an adapted version of Formula 9.3 for variable interest rates:

Follow these steps to adapt Formula 9.3 for percent change applications:

Step 1 : Assign either the “Old” value to \(PV\) or the “New” value to \(FV\) (depending on which you know).

Step 2 : Identify your series of percent changes (\(i_1\) through \(i_n\)) and how many times in a row each percent change value occurs (\(N_1\) through \(N_n\)). Remember that decreases are negative values.

Step 3 : Apply the adapted version of Formula 9.3, solving for either \(FV\) or \(PV\).

As an example, find out the new value for the \(TSX\) based on a starting value of 12,000 with decreases of 4% for five months followed by increases of 4% for five months.

Step 1 : The “Old” value is \(PV\)=12,000.

Step 2 : The first change is a decrease of 4%, or \(i_1\) = −4%. It occurs for five months in a row, thus \(N_1\) = 5. Next, an increase of 4%, or \(i_2\) = 4%, also occurs five months in a row, thus \(N_2\) = 5.

Step 3 : Use Formula 9.3 to calculate \(FV = 12,000 × (1 − 0.04)^5 × (1 + 0.04)^5 = 11,904.31\). The “New” value of the \(TSX\) after the 10 months of change is 11,904.31.

You can use your financial calculator f or these nonfinancial calculations just as you did for inflation. You must follow the cash flow sign convention by ensuring that \(PV\) and \(FV\) have opposite signs. However, once again the signs do not have any meaning in these calculations.

When you work with variable inflation rates, purchasing power of a dollar, or rates of change, you can simplify the variable rates into a single fixed rate using a geometric average before applying the compound interest formula. For example, using the \(TSX\) example above, the geometric average of the 10 months of change is:

\[GAvg =\left [\sqrt[10]{(1-0.04)^{5} \times(1+0.04)^{5}}-1 \right] \times 100=-0.080032 \% \nonumber \]

Using this calculated value as the periodic interest rate and substituting into Formula 9.3 produces:

\[FV = 12,000 × (1 − 0.00080032)^{10} = 11,904.31\nonumber \]

Similarly, you could solve Example \(\PageIndex{2}\) with this approach. Some students have found this technique easier than working with the variable rates. Either way, whether you use variable rates or the geometric average as the fixed rate, both techniques produce the same solution.

Exercise \(\PageIndex{2}\): Give It Some Thought

If a quantity decreases by \(x\%\) and then increases by the same percent, why do you not arrive at the original quantity as your “New” value?

The initial decrease will make the base number smaller. If the new base number is then increased by the same percentage, that percentage is determined from a smaller base. It will not produce the same value as the decrease.

Example \(\PageIndex{3}\): Changing Employment in Vancouver

The City of Vancouver tracks employment in its Metro Core area. In 1971, approximately 45,000 employees in the Metro Core area were classified as "professional and commercial service" workers. From 1971 to 1981, the number of workers grew by about 4.5% per year. From 1981 to 1991, the growth rate was about 3.1% per year, and from 1991 to 2001 the growth rate was about 1.5% per year.4 Rounded to the nearest thousand, how many people were employed in the "professional and commercial services" field in the Metro Core area of Vancouver in 2001?

You are looking for the “New” value (\(FV\)) of the number of employees after the 30 years of percent changes.

The beginning value and structure of the sequence of percent changes are known, as shown in the timeline.

Capture the values of \(i_n\) and \(N_n\) for each consecutive percent change value. Note that the timeline has three time segments, so each variable has three values.

Apply Formula 9.3.

\[i_{1}=4.5 \%, N_{1}=10, i_{2}=3.1 \%, N_{2}=10, i_{3}=1.5 \%, N_{3}=10 \nonumber \]

\[\begin{aligned} &FV=45,000 \times(1+0.045)^{10} \times(1+0.031)^{10} \times(1+0.015)^{10}\\ &FV=45,000 \times 1.045^{10} \times 1.031^{10} \times 1.015^{10}\\ &FV=45,000 \times 1.552969 \times 1.357021 \times 1.160540=110,058=110,000 \end{aligned} \nonumber \]

From 1971 to 2001, the number of employees in the "professional and commercial services" field in the Metro Core area of Vancouver grew from 45,000 to 110,000.

• Statistics Canada, “Average Annual, Weekly and Hourly Earnings, Male and Female Wage-Earners, Manufacturing Industries, Canada, 1934 to 1969,” adapted from Series E60–68, www.statcan.gc.ca/pub/11-516-x/ sectione / E60 _68eng.csv, accessed July 28, 2010.
• Statistics Canada, “Earnings, Average Weekly, by Province and Territory,” adapted from CANSIM table 281-0027 and Catalogue no. 72-002-X, www40.statcan.gc.ca/ l01 / cst01 /labr79-eng.htm, accessed August 11, 2011.
• Statistics Canada, “Consumer Price Indexes for Canada, Monthly, 1914–2012 ( V41690973 Series)”; all values based in May of each year; www.bankofcanada.ca/rates/related/inflation-calculator/?page_moved=1, accessed November 26, 2012.
• City of Vancouver, “Employment Change in the Metro Core,” November 22, 2005, http://s3.amazonaws.com/zanran_stora...es/7116122.pdf , accessed August 20, 2013

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How to Calculate Inflation

Last Updated: March 28, 2023 Fact Checked

This article was co-authored by Alex Kwan and by wikiHow staff writer, Jennifer Mueller, JD . Alex Kwan is a Certified Public Accountant (CPA) and the CEO of Flex Tax and Consulting Group in the San Francisco Bay Area. He has also served as a Vice President for one of the top five Private Equity Firms. With over a decade of experience practicing public accounting, he specializes in client-centered accounting and consulting, R&D tax services, and the small business sector. There are 9 references cited in this article, which can be found at the bottom of the page. This article has been fact-checked, ensuring the accuracy of any cited facts and confirming the authority of its sources. This article has been viewed 316,462 times.

Inflation measures how the value of currency changes over time. The prices you pay for things also change to reflect the changing value of the currency you're using. By calculating the rate of inflation, you can find out how fast prices are rising over a set number of years. This sounds complicated, but it's actually relatively simple to do on your own—you just need a price index for the beginning and end of the period you want to measure. Using the same information, you can also adjust prices for inflation. This allows you to look at historical prices using the same currency value so they're more understandable and easier to compare to current prices. [1] X Research source

Identifying Your Variables

• The prices you choose to measure inflation depend on the place where you want to measure.
• Your location also impacts the currency. For example, if you wanted to compare the rate of inflation between the US and Australia, you would measure US inflation in US dollars and Australian inflation in Australian dollars. Since the rate itself is expressed as a percentage, it doesn't matter that you're comparing different currencies.

• For example, in the US, you can use the CPI-U, which measures consumer prices for all urban consumers in the US, or the CPI-W, which measures consumer prices for a subset of urban consumers who earn more than half of their income from clerical or wage-earning occupations.
• The CPI provides an average of a "basket" of goods commonly purchased by the population measured.
• There are other indexes available for specific industries. For example, if you were calculating inflation for a cost estimate for a construction project, you might use the Construction Cost Index (CCI).

• For example, if you wanted to measure inflation over the course of a year, you would need the CPI number for the previous year and the CPI number for the target year. Your rate would tell you how rapidly prices increased during that year.

Working the Formula for Inflation

• For example, suppose you're using the Australian CPI and want to measure the rate of inflation between the 4th quarter of 2010 and the 4th quarter of 2018. The index number for 2010 is 96.9 and the index number for 2018 is 114.1. [7] X Research source Therefore, you would subtract 96.9 (the earlier CPI) from 114.1 (the later CPI) to get 17.2.
• If the result is a negative number, you have deflation rather than inflation. This means that for the period you're looking at, prices actually decreased and money increased in value.

• To continue the example, you subtracted 96.9 from 114.1 to get 17.2. If you divide 17.2 by the earlier CPI of 96.9, you get 0.1775 (rounded).

• Continuing with the same example, if you multiply 0.1775 by 100, you get 17.75%. Therefore, the rate of inflation in Australia from 2010 to 2018 was 17.75%.
• Another way to turn a decimal into a percentage is to simply move the decimal over 2 digits to the right.

Adjusting Prices to Control for Inflation

• As with calculating inflation, you can do this for different periods of time. For example, you could determine the rate of change over a 4-month period. You just need a beginning date and an ending date.
• For example, if you wanted to find out what something that cost $50 in 1984 would cost in 2019, you would start by dividing the CPI for 2019 (255.657) by the CPI for 1984 (103.9) to get 2.46 (rounded). [9] X Research source
• To find out what something that cost $50 in 2019 would cost in 1984, simply flip the numbers in your ratio and divide the CPI for 1984 (103.9) by the CPI for 2019 (255.657) to get 0.40.

• To continue the previous example, you would multiply $50 by 2.46 to get $123. This tells you that what cost $50 in 1984 would cost around $123 in 2019.
• If you flipped the numbers to get 0.40, you'd find that what cost $50 in 2019 would cost $20 in 1984.
• You can use the adjustment formula to find out the value for something at any time, not just the present day. Just sub the period you want for the "current CPI" in the equation. For example, something that cost $50 in 1920 (CPI 20.0) would cost $326.75 in 1990 (CPI 130.7) because $50 x (130.7/20.0) = $326.75.

• Adjusting for inflation makes the prices more understandable to you and your audience. For example, the price of gas in 1950 was only 27 cents a gallon, which might sound incredibly inexpensive. [12] X Trustworthy Source U.S. Department of Energy Official site for the U.S. Department of Energy, which provides resources related to energy safety, conservation, and efficiency Go to source However, adjusted for inflation, that price would be $2.86 in 2019 dollars — not much different from what you paid for gas in the US in 2019.
• If you were comparing American gasoline prices for every year from 1950 to 2019, you would apply the adjustment formula for each year (except for 2019, which is already in 2019 dollars). Your resulting table would be in constant 2019 dollars.
• If you're working on a spreadsheet, input the corresponding CPI ratios in one column and multiply the column of raw prices by the CPI column to adjust all the prices in your set.

Calculator, Practice Problems, and Answers

Expert Q&A

• If you're using the US CPI, you can calculate inflation between years using the online calculator available at http://data.bls.gov/cgi-bin/cpicalc.pl . This calculator is provided by the US Bureau of Labor Statistics, which calculates and reports the US CPI. Similar government agencies in other countries may have similar online calculators available. Thanks Helpful 0 Not Helpful 0
• If you're doing a problem for a class in school, your variables may be provided to you. For example, you might be given prices for an item in 2 different years and be asked to calculate the rate of inflation. The formula works just the same, simply use those numbers instead of a CPI number. Thanks Helpful 0 Not Helpful 0

You Might Also Like

• ↑ https://www.seattle.gov/city-budget-office/inflation-consumer-price-index/frequently-asked-questions
• ↑ https://www.maa.org/press/periodicals/loci/joma/the-consumer-price-index-and-inflation-calculate-and-graph-inflation-rates
• ↑ https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/MSB/feature/CPI
• ↑ https://www.ato.gov.au/Rates/Consumer-price-index/
• ↑ https://www.youtube.com/watch?v=ReRYI86Ovms
• ↑ https://www.usinflationcalculator.com/inflation/consumer-price-index-and-annual-percent-changes-from-1913-to-2008/
• ↑ https://www.youtube.com/watch?v=K5_5LwQSRdk
• ↑ https://faculty.fuqua.duke.edu/~rnau/Decision411_2007/411infla.htm
• ↑ https://www.energy.gov/eere/vehicles/fact-741-august-20-2012-historical-gasoline-prices-1929-2011

About This Article

To calculate inflation, start by subtracting the current price of a good from the historical price of the same good. Then, divide that number by the current price of the good. Finally, multiply that number by 100 and write your answer as a percentage. For example, if bread cost $2 USD in 2018 and $1 USD in 2010, you would subtract 1 from 2 and get 1. Then, you would divide 1 by 2 and get 0.5. Finally, you would multiply 0.5 by 100 and get 50 percent. To learn how to find the historical price of different goods online, read on! Did this summary help you? Yes No

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Lesson of the Day: The Math of Inflation

Prices are going up for everyone, but some feel the increase more than others. In this lesson, students will use mathematics to understand inflation and its unequal effects.

By Taylor Kockenmeister

Lesson Overview

Featured Article: “ Americans Say High Prices Are Hitting the Things They Need to Get By ” by Emily Badger, Aatish Bhatia and Quoctrung Bui

Have you noticed that things are more expensive lately? According to a recent poll for The Upshot, nearly nine in 10 Americans say they have noticed prices increasing for essential items like gasoline, meat and dairy products. The culprit? Inflation.

Inflation, according to The New York Times , “is a loss of purchasing power over time: It means your dollar will not go as far tomorrow as it did today.” Although a normal part of the economic cycle, when prices rise too rapidly as they are now, inflation affects consumers. But how much it concerns you can depend on how much money you make.

In this lesson, you will use mathematics to understand inflation and its unequal effect across income levels. You will graph the change of the dollar’s value over time, calculate the percent increase of various essential items using the Consumer Price Index average price data, and determine the percentage that different income groups spend on food and how that affects how inflation is felt.

Note: If you want to know more about the basics of inflation, start with our “ Lesson of the Day: ‘Inflation Has Arrived. Here’s What You Need to Know.’ ”

Take a close look at this graph from the article “ Worried About Inflation? Here’s What That May Reveal About You .”

Then respond to the following questions in writing or a class discussion:

What do you notice? What do you wonder?

What is one sentence you can use to summarize the data in the graph?

What might this graph tell us about how different income groups feel the effects of inflation?

Reading and Questions for Writing and Discussion

Read the featured article , and respond to the following questions:

1. What did the survey cited in the article reveal about inflation?

2. Why are Americans more concerned about inflation now than they have been for the past 40 years?

3. The article says that even though higher- and lower-income respondents noted seeing inflation in the same places, they are not necessarily experiencing it in the same ways. How so? Can you give an example?

4. What does the outsize importance respondents placed on food prices tell us about how people formed their views on inflation?

5. Are you concerned about inflation? Why or why not?

Math Activity 1: Graphing the Changing Value of a Dollar

You’ve probably heard your grandparents, parents and other older people lament the rising costs of items, saying things like, “Back in my day, that cost a nickel.”

Are things really getting more expensive? To understand the inflation we’re seeing today, first you’ll need to understand it over time.

Use this inflation calculator from the U.S. Bureau of Labor Statistics to explore the dollar’s buying power at different points in time. Choose a dollar amount, and see how its value has changed by adjusting the first year (the second date should remain March 2022, the most recent date for which the B.L.S. has data).

Determine 10 to 12 data points between 1913 (the furthest the calculator will go back) and March 2022. Record your values in a table, and then plot them on a scatter plot. You can use this printable PDF to help.

Share your graph with the class. Then respond to the following questions in writing or a class discussion:

What general trends can you discern regarding the value of the dollar?

What does it mean when a dollar loses or gains value? What is the impact for consumers?

Does this scatter plot show positive or negative association? What does that mean?

Do you notice any outliers in the data? If so, what might explain them?

Does this scatter plot show linear or nonlinear association? What does that tell us about inflation?

Math Activity 2: Calculating the Inflation Rate of Essential Items

As you’ve seen, the dollar has gradually lost value over time as a result of inflation. This is a normal part of the economic cycle — policymakers generally believe that, for a healthy economy, an inflation rate around 2 percent or a bit below is acceptable. But when prices rise too quickly, consumers feel the change.

What are inflation rates like now? The Bureau of Labor Statistics uses a tool called the Consumer Price Index to measure the aggregate, or collective, price level of goods and services, such as clothing, education and food in our economy and see how quickly prices are changing.

This index shows that the average price of gasoline in March, the most recent date for which there is data, was $4.312, bacon was $7.203 and electricity per kilowatt was $0.150. These numbers don’t necessarily mean much on their own; what tells us about the rate of inflation is how much they fluctuate. We can calculate these fluctuations by using the percent-change formula of the average prices within the C.P.I.

As an example, let’s take a look at the average price data on potato chips from January 2020 to March 2022.

We can see that this graph shows a general positive association, meaning that, overall, the cost of potato chips is increasing. We can also observe that the price fluctuates often, meaning it isn’t linear or predictable.

To determine how much the price of an item is increasing from various years, we can use the percent-increase formula shown below:

Let’s take a look at the price of potato chips in March 2020 ($4.63) and March 2022 ($5.487). Here is how we would use the percent-change formula to determine the rate at which potato chips have increased in price between those two dates:

Now, use the Average Price Data from the Bureau of Labor Statistics Data Finder to investigate various items and determine the percent by which the price has changed during a set amount of time. Document your findings in a chart to analyze as a class.

(Note to teachers: It might be helpful to decide as a class what date ranges to explore together — for example, 2020-2022 or 2015-2022 — in order to notice trends.)

Respond to the following questions in writing or in a class discussion:

What do you notice and wonder about the data? What general trends can we discern?

Do you think inflation is rising at a “healthy” rate? Why or why not?

How might the inflation rate affect consumers? Will it affect certain groups of people more?

Math Activity 3: Understanding How Inflation Affects Income Groups Differently

Read this excerpt from the featured article:

“Sitting here as a high-income suburban mom, if you asked me when did I first see it, I would also answer in a pound of ground beef,” said Diane Whitmore Schanzenbach, a Northwestern University economist who studies poverty. The price of ground beef has risen more than 13 percent in the past year. “But the price increase is just annoying to us,” she continued. “It has not meant that I’ve stopped feeding the kids their favorite food.” To poorer families, the difference can mean hunger. When we asked respondents if they wished to share anything else, many volunteered that rising prices even on small purchases have left them making difficult choices.

What does this passage tell us about inflation? If prices are increasing at the same rate for all of us, why do you think inflation might have a more substantial effect on people with lower incomes?

To understand this phenomenon, we can use some simple math.

Take a close look at the chart below with data from the University of Pennsylvania showing the amount of money that different income groups spent on food in 2020. (The 0-20 Income Group makes the least amount of money annually, while the 95+ group makes the most.)

Do these numbers alone tell us why people with lower incomes might feel inflation more strongly? Not quite. It can be difficult to compare absolute dollar amounts; percentages are better because they show us parts per hundred. If we can determine the part for every hundred between different quantities, we can make more accurate comparisons across different amounts.

Let’s calculate the percentage of total annual spending that each income group spends on food with the following percentage-calculation guidelines. Record your numbers in the last column of the table and compare them.

What do you notice about the percentage of each group’s total annual spending on food?

Based on this data, what income percentile might feel the impact of inflation the most? Why?

Return to the excerpt you read at the beginning of this activity. How might these numbers explain why, to a high-income suburban mom, inflation is “just annoying,” and to poorer families, “the difference can mean hunger”?

Discussion and Reflection

Answer the following questions in writing or in a class discussion:

We’ve used mathematics to graph the changing value of the dollar, determine the inflation rate and calculate percentages of spending to each income level. How do these topics connect to provide us a better understanding of who is most heavily affected by inflation?

How do the article and the math activities help explain the graph you looked at in the warm-up activity at the beginning of this lesson? Why might low-income families be more concerned about inflation levels than richer ones? What evidence can you use to back up your claims?

After completing the lesson, how concerned do you personally feel about rising inflation? How might it affect your community?

Going Further

Choose one or more of the following activities to dive deeper into topics related to inflation — why it’s happening now, what we can do to curb it and more.

The Intersection of Wages and Inflation

Read the following excerpt from “ Wages Are Rising, But Can They Keep Up With Inflation? ”:

American workers are taking home bigger paychecks as employers pay up to attract and retain employees . But those same people are shelling out more for furniture, food and many other goods and services these days. It is not yet clear which side of that equation — higher pay or higher prices — is going to win out, but the answer could matter enormously for the Federal Reserve and the White House. There are a few ways this moment could evolve. Wage growth could remain strong, driven by a tight labor market , and overall inflation could simmer down as supply chain snarls unravel and a surge in demand for goods eases. That would benefit workers. But troubling outcomes are also possible, and high on the list of worries is what economists call a “wage-price spiral.” Employees could begin to demand higher pay because they need to keep up with a rising cost of living, and companies may pass those labor costs on to their customers, kicking off a vicious cycle. That could make today’s quick inflation last longer than policymakers expect.

Discuss as a class: What is the “wage-price spiral,” and how might that impact inflation? Will we ever be able to evade the challenges mentioned in the article?

Are wages keeping up with inflation where you live? Use the Living Wage Calculator to see the hourly rate needed to support a person and a family. Would a minimum-wage salary be enough to support an adult? What about an adult with a child? Or a couple who both work and have two children? What does this mean for your community?

Who’s to Blame for Inflation?

Read this excerpt from “ Rapid Inflation Fuels Debate Over What’s to Blame: Pandemic or Policy ”:

At a moment when stubbornly rapid price gains are weighing on consumer confidence and creating a political liability for President Biden, White House officials have repeatedly blamed international forces for high inflation, including factory shutdowns in Asia and overtaxed shipping routes that are causing shortages and pushing up prices everywhere. The officials increasingly cite high inflation in places including the euro area, where prices are climbing at the fastest pace on record , as a sign that the world is experiencing a shared moment of price pain, deflecting the blame away from U.S. policy. But a chorus of economists point to government policies as a big part of the reason U.S. inflation is at a 40-year high. While they agree that prices are rising as a result of shutdowns and supply chain woes, they say that America’s decision to flood the economy with stimulus money helped to send consumer spending into overdrive, exacerbating those global trends. The world’s trade machine is producing, shipping and delivering more goods to American consumers than it ever has, as people flush with cash buy couches, cars and home office equipment, but supply chains just haven’t been able to keep up with that supercharged demand.

What happens when there is excess demand and low supply?

How might the stimulus checks sent to Americans during the pandemic have played a part in inflation?

What would a significant increase in minimum wage do to the value of the dollar? Would that boost help those struggling to make ends meet or not?

Engage in a classroom auction to simulate the increased prices when there is extra money in the economy (demand) without the additional items for consumers to purchase (supply).

Learning From Past Failures on Inflation

Listen to “The Daily” podcast episode “ Inflation Lessons From the 1970s .”

Listen to ‘The Daily’: Inflation Lessons From the 1970s

Painful lessons from the past have helped convince policymakers that quickly raising interest rates is the way to combat rising prices..

From The New York Times, I’m Michael Barbaro. This is The Daily.

Later today the U.S. government is expected to deploy its most powerful tool for fighting inflation, knowing full well that it will weaken the economy. I spoke with my colleague, Jeanna Smialek, about why that is and the painful lesson from a previous era that has convinced American policymakers that this is the right path.

It’s Wednesday, March 16th.

Jeanna, The Federal Reserve— in just a few hours, we think— is going to raise interest rates in order to lower inflation in the American economy. Can you just help us understand the mechanics of that? How does that work?

So as everyone knows, prices are rising really quickly right now on cars, on meat, on couches. And there are a few reasons for that. The government spent a lot of money at the start of the pandemic and throughout last year to sort of blunt the impact of the coronavirus and its effect on workers.

Right, there were stimulus checks, for example.

Exactly. And that spending fueled really strong demand. Unfortunately, that strong demand collided with supply chains that were all messed up. And so there were too many dollars chasing too few goods and inflation really jumped up.

Today, even though the government is spending less, the checks have stopped. The labor market is really strong. And that’s helping to sustain this pretty robust demand and it’s keeping inflation rising. And so we have this real problem where prices have been going up a lot. And now the Fed is getting worried that inflation is going to get stuck at this higher rate that they do not want.

And so the idea is if you raise interest rates, if you make it more expensive to borrow money to buy a car or to borrow money to buy a house, then fewer people will do those things. There will be less demand and supply will have a chance to catch up, which will allow price increases to slow down a little bit.

Right. When the Fed raises the interest rate, it essentially pours a tall glass of cold water on the economy. It deliberately tries to slow down spending.

Right. You slow things down to bring inflation under control.

Which has always struck me as kind of strange because what you’re describing is a process of our own government hurting the economy in order to eventually help the economy.

Right. And so this is the way that central bankers control inflation everywhere. But here in the United States, there’s a good reason why central bankers tend to be especially attuned to periods where it seems like inflation might hop out of control. And that is because there’s a historical example where they did not react quickly enough to inflation, where inflation became really painful. And it’s this period that kind of haunts the nightmares of central bankers.

So tell us the story of that time period that haunts economists. When did it start?

So the story starts in the mid to late 1960s, really during Lyndon B. Johnson’s presidency, when there is just this huge amount of government spending happening.

This administration today here and now declares unconditional war on poverty in America.

Johnson famously tried to tackle poverty in this ambitious program called the Great Society.

Our chief weapons in a more pinpointed attack will be better school and better health and better homes and better training and better job opportunities to help more Americans escape from squalor and misery.

And while that’s happening, the country still engaged in the war in Vietnam.

I have told the American people that we would send to Vietnam those forces that are required to accomplish our mission there.

And that’s also increasing government spending by billions and billions of dollars.

2 and a half billion dollars in this fiscal year and 2,600,000,000 in the next fiscal year.

So there’s a lot of government money pouring into the economy and inflation just starts to gradually ratchet up year after year. And many economists think that the government spending from the 1960s helped to kick off that process. But then inflation keeps on rising.

Spiraling inflation now appears to be a fixture in the American economy and it’s casting a shadow on the American dream of doing better and better every year.

By the 1970’s, this spiraling inflation had another important effect on Americans.

The nation was developing a psychology of inflation. The seller asks more than he needs, helping to cover the cost increase that’s sure to come. And the buyer buys now because the price will only get worse later.

People began to change the way they thought about their money, the way they thought about inflation.

Why aren’t people saving these days?

The psychology is, well, tomorrow everything is going to cost me more. It’s an inflation cycle, so I better buy now and the heck with saving.

So Americans began to feel like their money wasn’t going to go as far because prices were so high and they began to ask for higher wages to cover their rising expenses. And you saw that as companies had to pay more, they started charging more to cover their costs. And we ended up in a situation where prices and wages were in this upward spiral and they were kind of chasing each other.

And so that proceeds through the 1970s. And we’re really seeing these very, very rapid price increases on a year-over-year basis.

And it’s worth pausing just a moment to understand what high inflation like that actually feels like. Groceries are a good example because they bounced around a lot but at times hit double digit inflation in the 1970s. Given those rates, if you had a $100 grocery order in 1970, it would have cost about $170 in 1978 to buy the same exact things.

We’re in an energy crisis now and will be for some time to come. We have, at present, an absolute shortage of natural gas.

And during the 1970s, both in the early 70s and then in ‘79, there were oil embargoes.

Petrol stations can no longer afford to fill up cars whose tanks take 20 gallons. The monsters are dying of thirst. The energy crisis is killing them.

And so when those happened, they sort of supercharged this already very high inflation and pushed the cost of gas up quite a lot. And so between gas and food and all of these sort of day-to-day necessities, you just saw a wide variety of consumer goods starting to become more expensive. It really became sort of this economy-wide problem where prices for everything were going up and it wasn’t clear how it was going to end.

And how did Americans feel about all this inflation?

Americans did not feel good about all of this inflation, especially in the 1970s when it started really hitting oil prices because they are just so visible. You see them up on a price board and it just was such a big part of people’s everyday lives. So people were angry about it. It is just everywhere in the culture. You see it in old magazine articles. You see it in comic strips.

And now folks, the host of The Price is Wrong, consumer specialist, David Haworth.

Comedians are making jokes about it.

Thank you, thank you, thank you. And welcome to The Price is Wrong, the game that deals with your survival and self-respect in these inflationary times.

It shows up in All in the Family, the sitcom.

It’s the administration. It’s causing all your problems. Where do you think your inflation comes from? I know where my inflation comes from— from the gas that you give me.

And so this just became a sort of everyday kitchen table issue here in America.

So what did the U.S. government do to address this?

Not as much as you might think. And the reason for that is elected officials are not especially good at cooling down the economy enough to wrestle inflation under control because obviously if you want to win reelection, you do not want to slow down your economy and possibly tip it into a recession. And so politicians talk about it a lot, but they really don’t sort of roll out any super aggressive policies that are enough to constrain prices.

And then at the same time, you have central bankers who for various reasons over the years really just aren’t willing to raise interest rates enough and sort of hurt the economy enough to bring prices under control. And so basically there’s just no sort of concerted government response that is effective at bringing down inflation in these years. The can keeps getting kicked down the road and we end up with very high inflation that is sort of embedded in the fabric of society and feeding on itself.

Right. And no one’s willing to do anything about it.

Or at least not enough. And that was basically the case for a decade until 1979. President Jimmy Carter is at the helm. He’s struggling to salvage public confidence in his administration and the economy is just a disaster. So he starts to shuffle cabinet members around, which opens up the top position at the Federal Reserve. And he calls up this candidate named Paul Volcker.

Volcker’s already a senior official within the Federal Reserve System and there’s a few things he’s known for. First, he’s very tall, 6 foot 7. He’s also frugal. He likes drugstore cigars. He wears badly fitted suits and he continued driving a car with a broken seat around after he broke it. And he kind of applies all of that frugality to his economic policy. Up until this point, he’s been pretty frustrated with the Fed’s half-hearted attempts to curb inflation and he wants the Fed to take a harder line approach.

So Volcker gets to his Oval Office interview and basically tells Jimmy Carter that if he gets the job, he’s going to push interest rates higher. And the clear implication there is that he’s going to support a policy that hurts the economy while Carter is still in office and that he’s not going to continue to allow inflation to just run out of control the way it’s been doing. And so he goes home from this interview absolutely positive that he’s not going to get the job given what he’s just told the president.

Right because he just told the president, I’m going to make you unpopular.

Exactly, exactly. And so he’s flabbergasted when the next morning, his phone rings very early in the morning— he’s still in bed— and it’s Jimmy Carter. And Carter tells him, hey, you got the job.

And suddenly Paul Volcker finds himself chairman of the Federal Reserve.

Now, my thesis can be summed up in just a few sentences. First, we need to bring inflation down and restore price stability. We need to do it not just for its own sake but because lack of confidence in our currency is incompatible with a productive growing economy. We need to build on the consensus that inflation is at the core of our economic problem. That is its public enemy number one. We need to resist temptation to stimulate the economy through —

We’ll be right back.

So, Jeanna, once Paul Volcker is the head of the Federal Reserve, what does he do?

So Paul Volcker basically makes good on what he has promised President Jimmy Carter, which is he wages a war on inflation. And we really see that start in earnest in October 1979.

There’s the super dramatic scene. On a Saturday night, Paul Volcker decides to hold a press conference, which at the time is very rare. The Fed doesn’t do a lot of these.

And on a Saturday night.

And on a Saturday night, right? And not just any Saturday night, on a Saturday night when the pope is in town.

And so the Washington press corps is very devoted to following the pope around. And Paul Volcker and his communications staff call up the press and say, no, come on down to the Eccles building. And Volcker’s spokesperson actually has to convince some of the press to show up to this, including the CBS cameraman who basically says, I have limited resources and I’m going to the pope. And the press person says, long after the pope is gone, you’re going to remember what happens tonight.

So a lot of drama, a lot of pomp and circumstance. The press comes down. And Volcker basically tells the press that the Fed is going to change how it’s setting monetary policy, that they are going to shake up their whole approach and the whole goal here is really just to vanquish inflation, to bring it down once and for all, to really get a handle on this. This is basically a declaration that things are going to change.

Right. And how does he do it?

Volcker was really committed to the idea that you had to crush inflation completely to get America out of this self-perpetuating cycle. And so he gets aggressive. He took an interest rate that was already at 10 percent in 1979 and basically pushed it up to 17.6 percent within like a year. By early 1981, his policies pushed rates up to about 19 percent.

And soon it’s close to 20 percent. And that’s just this incredibly high interest rate and has ratcheted up there in an incredibly short amount of time.

And just for a moment, explain what it means for the interest rate to be almost 20 percent in the United States because it’s kind of hard to fathom.

So remember interest rates very directly translate into how much it costs to buy a house, to borrow to buy a car, or to borrow with a credit card. So let’s just take a house, for example. If you buy a $100,000 house and you’re going to pay it off in 30 years without any interest on that loan— which isn’t realistic, but just for the example— your payments are going to be about $300 a month.

Of course, if you’re paying a mortgage rate and the interest rate on your loan is 20 percent, so around that 1981 level, your payments would be closer to $1,700 a month. So that could obviously be prohibitively expensive, especially if you’re dragging it out over time.

It costs so much to borrow at this stage that you’re paying thousands, maybe tens of thousands more than you previously would have just to buy a car, a house, a boat, whatever it is that you want to borrow money to buy.

And so people just stop doing it. They just stop spending money on those things. And as that happens, America sinks into recession and that recession is really painful.

How bad? Describe it.

They came in all shapes and sizes, all ages and all backgrounds. Almost 1,000 of them showed up at City Hall in Soddy-Daisy today. Lined up from one end of the hall to the other, they were all there in response to a help wanted ad.

Unemployment rose above 10 percent.

All these people stood in line today and filled out applications at Chattanooga’s Employment Security office.

Just no jobs, not here in Chattanooga, I guess. No jobs here.

The human impact of what Paul Volcker is doing with policy is just palpable at this point. People are out of work. People are seeing their wage growth absolutely crushed. You’ve got car lots full of cars that just can’t sell. You’ve got homebuilders who just can’t sell houses.

So what you see happening is just this outpouring of anger because people know that interest rates are the thing inflicting so much damage and so much pain throughout the economy. They know that this is Fed policy driving this terrible recession.

And so people mail two-by-fours— homebuilders mail two-by-fours to the Federal Reserve in protest of the houses they can’t sell. The car dealers mail car keys in protest of the cars they can’t sell. And you see at one point, farmers actually bring tractors and circle the Fed in Washington out of protest of these very high interest rates and the intense pain that is being felt just throughout the entire economy at this stage.

But, Jeanna, it almost sounds like the cure was worse than the disease. While inflation was bad, people were not losing their jobs or getting priced out of loans for homes and cars the way they were once interest rates soared, right?

Right. So that is actually a school of thought that it was worse to raise interest rates than it would have been to let the inflation go. But most economists will tell you that if inflation would have gone unchecked, it might have gotten worse. And the uncertainty around how much money was going to be worth in the future could have been really harmful for the economy and just for Americans as a whole.

So how do you plan or save if you don’t know what $1 is going to buy in a year? And so it just wouldn’t have been a solid foundation to use to build up the rest of the economy. And Volcker was very, very aware of how painful this all was. And we know now that he really agonized over what he was doing to the economy during this period. In his memoir, he describes this patch of carpet in his office that he literally wore out from pacing it so much.

And he heard a lot of feedback. People publicly blamed him for just about everything.

There are those who claim Paul Volcker is the real father of this recession. Mr. Volcker, welcome. First, are you willing to accept parenthood for this recession?

I’ll claim no paternity. I don’t even like the question being asked that way.

But he didn’t stand down. There’s this moment that’s pretty well known in the nerdy circles that I run in— when he was prodded on a show called The MacNeil/Lehrer Report.

Let’s not forget that while people are concerned about a recession right now— and that’s understandable— we have had and still do have a problem of inflation. And as I suggested earlier, if we fail to deal with that inflation in a constructive way, I think we can look forward to a lot more economic instability. The better job we do on inflation, the better this economy will behave over a period of time. I don’t think there’s any doubt about that.

And Volcker was encouraging the country to basically keep this bigger picture in mind.

Do you feel that the strategy that you laid out in October to control the money supply is in fact working?

Where you wanted it to.

Yeah, well, it’s working in the immediate sense. We’re more perfectly on track, maybe partly by luck, than one could have imagined. Now, if you look at the economy and you say things going in a beautiful way— obviously, they’re not going in such a beautiful way. We’ve had more—

I think overall he is definitely grappling with the pain he’s causing the economy. But he is sort of remaining dedicated to this broader goal and this broader plan which is to bring inflation down even if it costs a lot to do that.

Right. And, of course, the biggest question of all is, does this work?

It is very painful, but it does work. We eventually go from 14.6 percent inflation in March 1980 to closer to 1 percent inflation by 1986. And so you just see this really rapid, really extreme deceleration in price increases. And inflation is under control in a way that it hasn’t been in decades.

As that happens, you get a lot of really positive knock on effects throughout the rest of the economy. And so consumers start to have much more stable outlooks. Businesses also start to feel like they can plan ahead and that they don’t have to worry about prices just going crazy. And as those two things happen, we see it really affecting behavior.

Lately, American consumers have been shopping with even more vigor than usual.

I think everybody is in a good mood. By the looks of the mall, it looks like it’s full of people.

Businesses start to invest again.

The U.S. economy continues its seemingly inexorable expansion.

Consumers, as interest rates come down alongside inflation, are able to buy houses again. Cars are selling again.

On today’s announcement, the personal income shot up at the highest rate in 5 and a half years comes as the nation’s unemployment rate remained near a 30-year low.

Really by the late 1980s and early 1990s, we’re having a really strong, solid, steady growth economy.

A friend of mine told me try America Online. I said, why? I’ve got a computer.

Then in the 1990s—

Welcome. I don’t mind saving for retirement anymore. I can research mutual funds, chart all my stocks, and do my banking all from home any time I want.

You get a productivity boom as personal computers come online. And really just we’ve set the stage for these several decades of very strong, very stable growth. And that is sort of the legacy of this Volcker era.

So it’s not a stretch to say that Volcker did as he promised, slay the dragon of inflation with this strategy of higher interest rates and showed that hurting the economy in the short-term really does improve the economy in the long-term?

I think that has become sort of the economic consensus in the time since. Yes, I think people very much attribute the good outcome to Paul Volcker. So this does great things for Paul Volcker’s reputation in the intervening years. And one person who grew up in the inflationary era and who is a real big admirer of Paul Volcker is Jay Powell, the current Fed chair. And Jay Powell has talked publicly about his deep admiration for Paul Volcker.

So when you first became chair, you were seen— you were spotted numerous times carrying Paul Volcker’s book under your arm.

When Volcker’s autobiography came out a couple of years ago—

So I actually thought I should buy 500 copies of this book and just hand them out at the Fed. I didn’t do that. But it’s a book I strongly recommend.

Powell talked about how he thinks that he and his colleagues should be thinking about this example as something that they want to emulate.

I don’t think there has been a greater public servant in our broad area in our lifetimes. I mean, he really just did exactly what he thought was the right thing all the time. And he let the chips fall where they may. We can all hope to live up to some part of who he is.

And so really a long track record of just really looking up to this former Fed chair and his long ago predecessor.

And if you are somebody like Jay Powell and you study this era closely, as it sounds like Powell did, what is the big lesson of the 1970s and Paul Volcker that Powell would carry into a moment like this?

I think that the big overarching lesson is that you don’t want to let inflation carry on for so long that it becomes sort of a major part of how people think about the world because once that happens, it is so painful to cure. Powell, like many economists in this era, has really studied the pain that Volcker had to put the economy through. And nobody wants to see a repeat of that. It was a really miserable era.

And so I think the lesson is you get out ahead of this early. You take care of it as soon as it starts to become a problem. Basically, you don’t be the Fed in the 1960s and 1970s and just let this drag on year after year and kick the can down the road. You try and take care of it right away.

Right. Which is why later today Powell is going to raise the interest rate just a little, which will inflict a little bit of pain, you’re saying, so that he never has to do what Volcker did, which is raise it again and again and again and inflict a tremendous amount of pain on the American worker and the American economy.

Exactly. Powell is going to nudge the rate up a little bit at this meeting. And he’s probably going to sort of send a signal that the Fed is going to continue raising interest rates steadily throughout the year. But the goal here is to maybe eventually raise interest rates up to perhaps 3 percent. So nothing like the 20 percent that Volcker was touching by the early 1980s.

So instead of a tall glass of cold water being poured on the economy, it’s kind of like a spritz.

Right. And the sort of hope and dream here is to sort of cool off the economy, to pull down inflation, to get things under control, but to do that quickly and to do that in a gentle way so that you don’t have to inflict the tremendous amount of pain that Paul Volcker did in the 1970s and 1980s.

Well, Jeanna, thank you very much. This has been very enlightening.

Thank you for having me.

Here’s what else you need to know today.

In a dramatic show of solidarity with Ukraine, three European heads of state— the prime ministers of the Czech Republic, Poland, and Slovenia— traveled to Kyiv on Tuesday, despite heavy Russian shelling across the city.

Hi, nice to meet you. You all are welcome.

During a briefing, Ukrainian President Volodymyr Zelensky thanked the prime ministers for taking the risk of visiting him in a war zone.

Our law, for example, [INAUDIBLE] or people.

In Washington, the White House said that President Biden himself would travel to Europe next week to show his support for both Ukraine and NATO. Meanwhile, Russian forces said they had taken control of the entire region of Kherson in Ukraine’s South, where local officials said that Russian troops have been rounding up activists who opposed Russia’s presence.

Finally, Russia imposed sanctions against 13 American officials, including President Biden, Secretary of State Antony Blinken, and Defense Secretary Lloyd Austin in retaliation for U.S. sanctions against Russian officials.

Today’s episode was produced by Rikki Novetsky, Diana Nguyen and Mooj Zadie. It was edited by Liz O. Baylen, contains original music by Marion Lozano, Elisheba Ittoop, and Dan Powell and was engineered by Chris Wood. Our theme music is by Jim Brunberg and Ben Landsverk of Wonderly.

That’s it for The Daily. I’m Michael Barbaro. See you tomorrow.

Then answer the following questions in writing or in a class discussion:

Jeanna Smialek, a reporter covering the Federal Reserve and the economy for The New York Times, says “there were too many dollars chasing too few goods.” What does she mean? What was the cause? (Timestamp 2:26)

How is the Federal Reserve’s response to inflation by raising interest rates a possible solution? Does such a move make sense? Why or why not? (Timestamp 2:55)

How did the federal government’s slow reaction to inflation in the 1970s affect our economic challenges today? In your opinion, what can we learn from this failure and apply immediately?

The Effects of Inflation on Rural Indigenous Communities

Read the short article “Cost of Getting Food to Remote Indigenous Communities Rose 400% During Covid” from Vice. Then answer the following questions in writing or in a class discussion:

Why are food prices so high in remote northern First Nation communities?

How have climate change and the coronavirus pandemic affected the price of groceries in these communities?

How have these price increases exacerbated some of the challenges these communities already face?

In May of 2021, an article in Maclean’s reported on a TikTok video shared by Kyra Flaherty that displayed the prices of food and essential items at her local store in Iqaluit, Nunavut, one of Canada’s northernmost territories.

Scroll to the bottom of the article to see the prices of some of the items Ms. Flaherty shared. Then research the cost of similar items in your local community. Using the percent-increase formula, calculate the percent increase in cost that First Nation communities in northern Canada pay in relation to people in your community. Additionally, create a ratio and write a statement to further describe the additional cost these communities experience, as seen below:

Finally, respond to the following question in writing or in a class discussion:

What does the math show about inflation in rural Indigenous communities, like the one Ms. Flaherty is a part of?

Nunavut has the highest suicide rate in the world ; Ms. Flaherty said that affordable food is “suicide prevention.” What do you think she means by that? What does this statement tell us about how inflation might be felt differently across income groups?

Want more Lessons of the Day? You can find them all here .