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Inflation is defined as a significant and continuing rise in the general price level of goods and services - prices increasing over time. Deflation is the decrease of prices over time. Of course, prices do not inflate or deflate uniformly for all types of goods and services throughout all sectors of the U.S. economy. For example, the goods and services typically bought by consumers (individuals and families) are different than those bought by factories or foreign investors and the associated price changes may be different as well. Therefore, there are various ways to track price inflation and deflation, each way dependent upon the selected goods or services being considered.
For the average individual or family, the most relevant measure of price change over time is the Consumer Price Index, (CPI). The CPI tracks the overall price change for a fixed basket of goods and services bought by a typical working-class urban family. When one wants to reflect the effects of inflation on the purchasing power of families and individuals, personal or household income and expenditure totals would be adjusted using the CPI.
Additional indexes track price changes in other segments of the economy. The Producer Price Index tracks changes in the price of domestic goods bought by wholesalers, factories and businesses located in the United States. The Import and Export Price Indexes track price changes in agricultural, mineral, and manufactured goods bought from and sold to foreigners.
However, there are indexes established to measure price changes for the U.S. economy as a whole. The most widely used measure of aggregate price change for the entire U.S. economy is the Implicit Price Deflator, (also referred to as the GDP Deflator or the Implicit Price Index.) This index is based on the Gross Domestic Product and therefore reflects price changes in all goods and services transactions in the United States, including the consumer, producer, investment, government and international sectors.
The Implicit Price Deflator (IPD) and the Consumer Price Index are both useful indexes for figuring inflation rates. When one wants to measure inflation that effects the purchasing power of individuals and families, the CPI is most appropriate. When one wants a broad measure of inflation that effects the purchasing power of government agencies, nonprofit agencies, corporations and businesses, the Implicit Price Deflator (IPD) is most appropriate. Figuring inflation rates is the same for both indexes. The following explanation will use the Implicit Price Deflator.
Because it is an index number, the IPD compares the level of prices at a given time to some base period. Currently, the base period is the average level of prices that existed in 1992, which is set to equal 100. The average level of prices for all other years before and after 1992 are represented as percentage differences from the base. For example, in 1993 the IPD index stood at 102.6 which means that prices were 2.6% higher than they were in 1992. This would represent an annual inflation rate of 2.6% for the period. The formula for calculating the percent of price change (rate of inflation or deflation) between two periods is:
Period 2 Index number --------------------------- - 1.0 x 100 Period 1 Index number
For example, the index number for 1996 is 110.2 and for 1997 is 112.4. The percent change in prices, the inflation rate, over that 1 year period is:
112.4 ------- - 1.0 x 100 = 2.0% 110.2
A series of income or expenditure figures can be adjusted to reflect the impact of inflation on the purchasing power of each figure in the series. For example, a government agency that expends $100,000 every year for ten years, receives fewer and fewer goods and services each year because prices have increased. In this example, the figure for each year can be adjusted using the Implicit Price Deflator, to show this reduction in purchasing power.
A series of figures in which each represents the dollar value of the income or expenditure transaction at the time it was made is referred to as a "current dollars" or "actual dollars" series. Adjusting a current or actual dollars series to show the impact of inflation on the purchasing power of each figure in the series converts the series into "constant dollars" or "adjusted dollars". For example, it is more useful to compare the change in annual wages measured in constant dollars than in current dollars because of the effect of inflation on purchasing power. While wages in current dollars may have risen across the years, wages in constant dollars may have declined because prices of goods and services that workers buy rose more than wages. In this example, a "current dollars" series would show an increase in wages while a "constant dollars" series derived from the current dollars series would show a decline in wages.
As is true for figuring the rates of inflation, unless one is interested in the specific purchasing power of individual and family consumers, the Implicit Price Deflator is the best index to use for inflation adjustments. To adjust a series of numbers, select an IPD index number which will serve as the base year for the series. Although not mandatory, often the base year selected is the same one designated as the IPD base year, currently 1992 = 100. The calculation is based on the following ratio:
Year Z current dollar value Year Z IPD index number ---------------------------- = ---------------------------- Year Z constant dollar value Base year IPD index number
To adjust a series of numbers for inflation, use the following formula to convert each figure in the series from current dollars to constant dollars.
Year Z current Base year IPD
dollar value x index number
Year Z constant dollar value = ------------------------------------
Year Z IPD index number
Below is a table offering two examples of the same series of numbers adjusted for inflation. This table shows how much money was expended, by some imaginary city, for social service programs over the ten year period 1985 - 1995. In current dollar terms, the city has increased its expenditures from $125,000 in 1985 to $132,000 in 1995. These figures appear in column C. However, once these figures are adjusted for inflation using the formula directly above, one observes a decline in purchasing power over the period. See column D. Using the IPD designated base year of 1992, one finds that city expenditures in 1985 purchased $159,439 worth of goods and services. By 1995, city expenditures were paying for only $122,448 worth of goods and services.
Column E illustrates the same principle as Column D, except Column E uses 1985 as the base year. Some people prefer to illustrate the effects of inflation on current dollars using the first figure in the series as the base year. Although the constant dollar values for each year are different between columns D and E, the percent change between years is the same. This means that either column reflects the same change in purchasing power over the ten year period.
City Expenditures on Social Service Programs: 1985 - 1995
A B C D E
Year IPD Index Current Constant Dollars: Constant Dollars:
Number Dollars Base year = 1992 Base year = 1985
1985 78.4 $125,000 $159,439 $125,000
1986 80.6 126,000 156,372 122,561
1987 83.1 126,500 152,226 119,345
1988 86.1 126,500 146,922 115,187
1989 89.7 128,000 142,698 111,875
1990 93.6 128,500 137,286 107,632
1991 97.3 129,000 132,580 103,942
1992 100.0 130,000 130,000 101,920
1993 102.6 131,000 127,680 100,101
1994 105.1 131,500 125,118 98,093
1995 107.8 132,000 122,448 96,000
The table below lists the implicit price deflator index numbers for each year from 1959 - 1995. Price measures related to the Gross Domestic Product, including the Implicit Price Deflator, are generated by the Bureau of Economic Analysis in the U.S. Department of Commerce. New IPD index numbers are generated quarterly, revised the following quarter, and converted into an annual figure every July. In addition, comprehensive benchmark revisions are made approximately every five years, a new base year is selected and all index numbers are changed accordingly. IPD index numbers are issued in the "Survey of Current Business" published by the BEA. Secondary sources of the IPD index numbers include "Economic Indicators" and the "Monthly Labor Review". All of these journals are available through the public library.
IMPLICIT PRICE DEFLATOR: 1959 - 1997
Year Index Number (1992=100) 1959 22.9 1960 22.3 1961 23.6 1962 23.9 1963 24.2 1964 24.5 1965 25.0 1966 25.7 1967 26.5 1968 27.7 1969 29.0 1970 30.6 1971 32.2 1972 33.5 1973 35.4 1974 38.5 1975 42.2 1976 44.6 1977 47.4 1978 51.0 1979 55.3 1980 60.4 1981 65.9 1982 70.1 1983 73.1 1984 75.9 1985 78.4 1986 80.6 1987 83.1 1988 86.1 1989 89.7 1990 93.6 1991 97.3 1992 100.0 1993 102.6 1994 105.1 1995 107.8 1996 110.2 1997 112.4
Source: Department of Commerce, Bureau of Economic Analysis
Copyright © 1998 Metropolitan Human Services Commission