How is the inflation rate calculated

Inflation Rate - Definition, Calculation & Effects


Everything about the inflation rate

Definition: Rate of increase in the price of a good or a service over a period of time

Measurement: The inflation rate is determined from the consumer price index (CPI)

Consequences:Devaluation of money, reduction in purchasing power

Forms of inflation: Creeping, trotting, galloping & hyperinflation

Counteract inflation: By investing in stocks like stocks or funds


It can be observed regularly that the prices of consumer goods such as a liter of milk, gasoline or coffee fluctuate. The consumer prices of services such as hotel accommodation are also subject to fluctuations in price development. Often these are normal fluctuations in price developments that are influenced by supply and demand.

On the other hand, it happenspermanentPrice increases, one speaks of oneinflation. At thisincreasesthegeneralPrice level one Wouldorservice by increasing the money supply by the central bank in the long term. In the following, the topic of inflation, especially with regard to the inflation rate, will be considered. This article explains what is behind inflation, what role the money supply plays in inflation and what the inflation rate means.

Definition: what is the inflation rate?

The rate of inflation orPrice increaseor rate of inflation gives the percentageriseofgeneralPrice levels at. The annual inflation rate thus serves as the Measuretheinflation. The inflation rate usually relates to one Periodofoneyear.

The basis for this calculation of the annual inflation rate is provided by Price indextheCost of Living (Consumer Price Index) dar, which in Germany monthly from statisticalFederal Office (StatBA) is determined with regard to a base year.

What does inflation mean anyway?

The word inflation is derived from Latin. "Inflatio" means something like "Inflate"or "swell" in the German language. In economics, inflation describes that continuous, permanent increase in a price of a good or a service.

Conversely, this means that the price increase means that you have less purchasing power for your money. A reduction in Purchasing power or inflation are the immediate consequences of the price increase. Inflation occurs, for example, when the demand is greater than the supply or a central body such as the European Central Bank (ECB) with a Measure like quantitative easing and an increase in the money supply intervened.

Note

The inflation rate was inYear 2018 at 1.9%. Unstable petrol and heating oil prices were particularly hard hit. The monetary policy of the European Central Bank for the euro area can be identified as the reason for the high inflation rate, which increases the money supply.

What is the purchasing power?

The purchasing power briefly mentioned above is also a term that is frequently used in economics. This describes how much of goods or services you can buy with your money. So this is what this is about Exchange ratiobetweenMoney and goods or services.

In inflation, purchasing power decreases due to rising prices for goods and services. Price increases lead to a decrease in purchasing power. In contrast to this is the so-calleddeflation.

Differentiation between inflation and deflation

Deflation is the direct opposite of inflation. Here The prices of goods and fallServiceswhy at the same time the Purchasing powerincreases. With deflation, you get more goods or services for your money. In contrast to inflation, the Currency strengthened during deflation.

Deflation occurs, for example, when aggregate demand is lower than aggregate supply. It creates a so-calledSales crisis.

Note

The last major inflation in Germany took place between 1914 and 1923. As a result of the First World War, the costs of everyday products fell massively. The devaluation was not long in coming. The oil price crisis in 1973/1974 also resulted in high inflation rates of up to 7%.

Why is inflation wanted?

Low inflation is wanted - especially on the part of the state. This uses inflation in some cases toNational debtdismantle. With more money in circulation, the national debt can be repaid more easily. The real value of the debt is falling.

Further the economy benefits from a low inflation rate. Consumers are encouraged to purchase more goods and services. It is also with one low inflation also makes it cheaper to borrow money. This also stimulates the economy as a whole, since it is not uncommon for loans to be taken out for consumption (consumer debt).

Note

The aim of the monetary policy of the European Central Bank is an annual inflation rate of 2%. The ECB takes active measures to influence the level of the annual inflation rate in the euro area.

What is the optimal inflation or why 2% is desired?

Low interest rates do not generate any interest income and a lack of wage increases slows down consumer spending, which ultimately has an impact on company shares. If inflation is too high, the effect risks tipping over again. Interest rates are rising massively, money is becoming more expensive for everyone.

But what exactly is optimal inflation? According to the ECB, inflation should be close to 2%. The primary goal of a central bank is price stability. However, this does not mean that prices will remain the same in the long term. It depends on the overall structure and economic development.

In the pursuit of price stability, deflation risks should be avoided, because deflation and inflation cause almost the same economic costs. Deflation, however, should be avoided, as it can solidify because of the limits set on monetary policy in the case of a normal interest rate level of around zero.

So the inflation target of 2% exists so that the European Central Bank has a buffer for fear of possible deflation.

How can this “buffer” provide help? The key interest rate of the ECB affects the interest on loans and thus influences the mass of money, low interest rates facilitate the granting of loans, higher interest rates this. If the flow of money is low, deflation threatens. It needs low interest rates. If the flow of money in the market is high, there is a risk of inflation. To counteract this, you need higher interest rates.

Differentiation between perceived inflation and the real inflation rate

Many people believe that they have regularly seen the topic of inflation with their own eyes. “Last time it was even cheaper,” customers like to complain. A scapegoat is quickly sought: inflation. The price increases observed often have other reasons and are not the result of inflation.

The so-called feltinflation describes the Rate of price increase that is subjectively perceived by the individual consumer becomes. As mentioned, these observations are subjective and can be strongly on actual measured inflationbased on statistical means.

Determination: How is the inflation rate measured?

After taking a closer look at the fundamentals of inflation, the question arises as to how the annual inflation rate is measured. An important component here is the so-calledConsumer price index (CPI). How the consumer price index helps to calculate the inflation rate will be clarified below.

Definition of the consumer price index (CPI)

The consumer price index is one economicidentification number. This is used to measure the averagePrice development used from a current year to a base year. It is a central indicator of the development of the value of money.

The CPI looks at households and the goods and services they buy for consumption in comparison with a base year. The consumer price index serves as the basis for calculating the inflation rate and is per monthfromStaBa updated. The basis for this is the representative shopping basket, which includes all updated five years.

While the CPI is used in Germany, the European Economic and Monetary Union on the so-called harmonized consumer index (HICP) as a key figure for measuring the price level development.

Note

An alternative to measuring inflation is, for example, the COLI (Cost Of Living Index).

What is a representative shopping cart?

The so-calledrepresentativeshopping cart is from statisticalFederal Office compiled. This is one virtualSummary that of one Average householdboughtGoods or services used. It is based on over 750 goods with more than 300,000 prices.

Typical product categories include:

  • flat
  • water
  • gas
  • food
  • health
  • leisure

These goods will every five yearscustomized, because they are supposed to represent the average of more frequent consumer goods and buying behavior changes over time. The representative shopping basket is used to collect the Consumer price indextoto calculate. This in turn forms the Basis for calculating the inflation rate.

Ask a problem for this imaginary shopping cartQuality improvementsofWererepresent. These are not always recorded. This is where the Federal Statistical Office comes into play. With the help of hedonisticPrice adjustment such improvements in the quality of the products should be taken into account.

Example calculations for the inflation rate

With strong inflation the prices increase progressively. Similar to compound interest, there are sometimes rapid increases in inflation. The actual inflation rate can be determined using a simple formula:

formula

Inflation rate = [(CPI index value new - CPI index value old) / CPI index value old] * 100

For example, the CPI for Germany in 2018 is an annual average of 111.4. In the previous year 2017, this was an annual average of 109.3. Substituting it into the formula gives: [(111.4 - 109.3) / 109.3] * 100 = 1.9%. The time periods can be chosen arbitrarily. In this way, for example, the change can also be determined on a monthly basis or over several years.

Furthermore, inflation has an impact on the Purchasing powerofMoney. This falls in line with the inflation rate. The products become more expensive and at the same time the money loses value. There is also a separate formula for the loss of purchasing power:

formula

Loss of purchasing power = [(current price / future price) - 1] * 100

To explain this, we assume an available purchasing power of € 1,000 and the above figures for the CPI and the inflation rate. Inserting it into the formula then brings the following results to light: Purchasing power loss = [€ 1,000 / (€ 1,000 * 1.019 inflation rate)] - 1 = -1.9%.

What are the consequences of a high inflation rate?

While low inflation is good for the economy, one is high inflation accordingly unfavorable or harmful. When the inflation rate is high, the population loses faith in the dominant currency. FurthersinksthePurchasing power clearly. Less is bought and everyone tries to be instead Investing moneyto avoid big losses from high inflation.

TheCentral bankengagesoftenawhen the inflation rate gets too high. Interest rates are increased and money creation is thus held back.

High inflation comes with additional consequences:

  • Savings and debts are subject to inflation
  • Reduction of the population's propensity to save
  • Increased investment in real assets

Causes of the inflation rate: why are prices rising?

There are many reasons for inflation. The most common reason is thatIncreasing the money supply through the central bank. In order to improve the liquidity of the markets, the central bank puts new money into circulation.

Overall, a distinction is made here between Demand and supply inflation. With demand inflation, demand is higher than supply. As a result, prices are rising. A higher wage level can be the trigger.

In supply inflation, prices are driven up for another reason. For example, if companies have higher personnel or raw material costs, these are passed on to the customers. So the company can continue to prescribe profits.

Forms of inflation

termpercentdefinition
Creeping inflationUp to 3%per yearHere the prices are slowly increasing. This often goes unnoticed.
Trotting inflationUp to 10 %per yearThis type of inflation is accompanied by medium price increases. The loss of purchasing power is noticeable.
Galloping inflationOver 10 %per yearDue to the rapid devaluation of money, there are considerable effects on a country's economy. There is a risk of hyperinflation. People are losing faith in their own currency.
HyperinflationOver 50 %per monthHere prices are rising so gigantically that consumers just want to get rid of their money. A flight of money sets in.
Homemade inflationThe causes of inflation are in your own country, not abroad (e.g. increase in crude oil prices)
Creeping inflationLess than 5% per yearInflation, in which the price level rises very slowly
Demand inflationInflation, in which an increased demand for certain goods causes prices to rise
Cost inflationArises from the fact that companies pass on increased production costs to the price of goods
Monetary inflationWith money supply inflation, the price increase is caused by the excess of money in the market

The different types or forms of inflation can be categorized according to “time”, “origin” or “cause”. In the following graphic, the various forms of inflation are to be distinguished on the one hand according to the cause of the price increase and on the other hand according to the speed and origin of the inflation that has arisen.

Development of the inflation rate in Germany

The development of the inflation rate in Germany over the last few years looks as follows:

  • 2016: 0,49 %
  • 2017: 1,51 %
  • 2018: 1,73 %
  • 2019: 1,51 %
Note

The Federal Statistical Office divides the current inflation rate for Germany 28th of every month With.

How can the effects of the inflation rate be negated?

An inflation rate of 2% means e.g. B. that savings worth € 1,000 after one year only have purchasing power of € 980. In order to negate this loss of purchasing power in the inflation rate, you should invest your money. The following table presents selected investment opportunities:

Daily and fixed deposit accountsWhen investing capital in overnight and fixed-term deposit accounts, it is important that the interest rates are above the inflation rate. Furthermore, possible tax payments should be taken into account. Protection against inflation is only granted if these conditions are met. With the low interest rate policy of the ECB, overnight and fixed deposit accounts are no longer a good investment option.
Precious metalsGold is not called a safe haven for nothing. The creeping inflation can be avoided by investing in this precious metal. Silver and other precious metals also offer investment opportunities. However, since precious metals do not yield any interest, the proportion of the portfolio should not exceed 5%.
propertyInvestments in real estate are also popular in times of inflation. The so-called concrete gold should, however, be consumed with caution. The location and rental structure should be taken into account to ensure protection against inflation.
Stocks, funds, ETFsInvesting in the stock market is considered particularly attractive. Especially during inflation and when central banks are printing new money, the stock market should rise. You can either invest directly in individual stocks or via investment funds or ETFs in stock indices. The main advantage of funds and ETFs is the diversification of risk, as investments can be made directly in entire indices or markets. Funds sometimes also mix in bonds or currencies for further diversification. However, it is important to carefully analyze the costs in order to achieve a return above the inflation rate after deducting all expenses.

Conclusion on the inflation rate

In the ten years since the 2008 financial crisis, consumer prices have risen steadily. The reason for this is inflation. Behind this is a term from economics. With inflation, the prices of goods and services rise permanently. On the other hand, there is deflation, in which prices fall permanently.

When it comes to inflation, many people rightly think of negative consequences such as monetary devaluation or loss of purchasing power and the associated danger for savings. There are actually only limited advantages for citizens. Middle-class citizens are particularly hard hit by inflation. For the economy, however, inflation is beneficial to some extent. Businesses benefit from increasing consumer purchases.

The inflation rate indicates the percentage of inflation. However, as long as this is in the desired range at just under 2% (or a little above), there is no need to worry. It is important for investors to find investments whose returns after deducting all costs are above the inflation rate in order to negate the negative consequences as best as possible. This is particularly important for old-age provision.

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