eli5: what is inflation and base year ?

Question

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

Additional is nominal.

In: 0

Answer 1

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.”