# eli5: what is inflation and base year ?

45 views
0

Have read some examples on the net but it’s getting confusing. Hardest part is the base year.

In: 0

ok, so the value of money has been changing since forever, yes? so, when we talk about how the value of money has inflated, we need to define a start point for our comparison. thats the base year.

&#x200B;

In some calculations, they use a specific, static base year as the start point, but in others, they use a floating one that is fixed relative to the present (ie “20 years ago”, as opposed “2003”), because that gives a more useful number for whatever the calculation is trying to work out.

&#x200B;

Now, one side effect of this is that the conditions of the base year can affect how the sums work out, and specifically, if the base year changes, it can change the outcome of the sum without the rest of the data really changing.

&#x200B;

For example, we start with a base value of 100. at the end of year one, we are at 150, so we can say we have a 50% annual inflation rate. At the end of year two, the value is 200, so the yearly inflation rate is only 33%, *even though everything went up by as much as it did last year*. the bi-annual rate would show 100% inflation, which is why you can sometimes get different answers of what the inflation rate is, depending on which maths you do..

&#x200B;

in the context of the current issues with inflation, we are facing a situation where something like this is basically going to make the headline inflation rate go up, not because of a change in the actual speed of prices going up, but a change in the basis of the comparison that makes it look that way.

First off: inflation is a general rise in the price of goods and services in an economy. If there is inflation then in general prices are going up. (Though sometimes we talk about “negative inflation” or a “negative inflation rate” meaning prices are going down.)

Usually when we talk about inflation we talk about consumer prices – the prices of stuff you and I buy, like housing, insurance, food, water. We can look at inflation in other ways though, for example, the costs for things businesses buy (power, raw materials, IT, training, etc.).

So, I want to know how much prices have increased. How much compared to *when*? Last year? The year before? Ten years ago? This “when” is the base.

*Usually* when we talk about inflation we’re talking about annual inflation. If I say “inflation in 2021 was 2% and 2022 was 7%” I’m comparing 2021 prices to 2020 and 2022 prices to 2021.

Another way to look at inflation is to set a base year – usually as 0% or 100 – and then compare all other years to it. So I might set 2020 as my base year and have:

2019: 98
2020: 100
2021: 102
2022: 109
2023: 115 (estimated)

This makes it easier to see the total change in prices over time.

“Nominal” is probably easier to understand than explain. It just means the regular, everyday money value of something. If something cost £10 in 2010 and £15 today, those are its nominal values.

If I earned £20,000 in 2010 and £30,000 today, those are my nominal wages. My nominal wages have gone up 50%. This is different from the “real” value of my wages: because of inflation I can’t actually buy 50% more stuff. If we adjust for inflation we get the “real” change in my wages.

Because we’re making a comparison, this needs a base year. We can’t just say “because of inflation my real wages are £25,000”. We can say “in nominal terms my wages have gone up from £20,000 in 2010 to £30,000 today, but in real terms they’ve only gone from £20,000 to £25,000.”