Measuring Inflation

In today's video, we're going to take a closer look at what inflation is and how it's measured. Now, shifts in supply and demand -- they're pushing some prices up and other prices down all the time.

Let's think about each of these prices like ping pong balls -- ping pong balls in an elevator. Now inflation is when the average price is going up. Inflation is when the elevator is going up. We measure the average level of prices using a price index, the average price from a large and representative basket of goods and services. There are different price indexes that are based upon different baskets. The consumer price index, or CPI -- it's based on a basket of thousands of goods and services which are bought by consumers in the United States. And, it's a weighted average, so that an increase in the price of a major item, like housing, that counts for more than an increase in the price of a minor item like toothbrushes. The inflation rate can then be measured as the percentage change in the index over a period of time, say a year.

So, let's take a look at the inflation rate in the United States, as measured by the CPI. If we google "Inflation United States FRED," we'll find a graph like this. The graph shows us the CPI. Now this index is defined, so that the average price in the years 1982 to 1984 -- that's set equal to 100. In mid-2016, the index was 239. So that means that over the past 33 years, prices on average have more than doubled.

Now that doesn't mean that we're necessarily worse off today than in the past because wages have also gone up over this time period. And, in fact, wages have gone up, on average, by more than prices. By clicking on edit data series, we can change to an annual series. Now we can see that in 1973 the CPI was 44.425. And in 1974, the average price of the CPI basket -- it had risen to 49.317. We can now calculate that the rate of inflation over this year was 11.01%. The calculations can be a little bit tedious.

So, let's have FRED do the work. We'll change the units to percent change from one year ago. We now see the annual inflation rate in the United States from 1948 to 2016. Notice that in 1974 the inflation rate was 11.01%, just as we calculated. You can see that the inflation rate increased in the United States in the 1960s and the 1970s, peaking around 1980 at a little over 14% per year. After 1980, inflation rates fell to an average of about 2.5% for many years. Inflation even turned negative, a little bit of deflation, very briefly during the 2009 recession. Even in the 1970s, the United States has had a relatively low inflation rate by world standards.

As a point of comparison, let's consider Venezuela today. In Venezuela, the inflation rate in 2015 hit 180%. And it didn't stop! It's estimated that in 2016, the inflation rate in Venezuela will hit 500%, or even higher. Now even Venezuela has a long way to go before it competes with a hyperinflation leader like Zimbabwe, which as we know from our previous video, Zimbabwe hit rates of billions of percent per month at its peak hyperinflation.

Okay. Now that we have a better idea about what inflation is and how it's measured, we're going to look in more detail at the causes and the consequences of inflation. That's up next.