Inflation Calculator

Understanding Inflation and Its Impact

Using Our Inflation Calculator

Our Inflation Calculator helps you understand how the purchasing power of the U.S. dollar has changed over time using historical Consumer Price Index (CPI) data from the United States. Simply input the original amount, the year it was relevant, and the year you want to adjust it to for inflation.

We also offer a Forward Flat Rate Inflation Calculator and a Backward Flat Rate Inflation Calculator. These tools allow you to explore hypothetical scenarios by calculating inflation-adjusted amounts based on a consistent inflation rate applied over a set number of years. Historically, inflation rates in the U.S. and many other developed nations have averaged around 3%, making this a reasonable assumption for theoretical calculations. However, you can adjust this rate as needed for your specific scenarios.

Historical U.S. Inflation Rate

The U.S. Bureau of Labor Statistics releases the Consumer Price Index (CPI) monthly, which is used to determine the inflation rate. Below is a table showing the historical inflation rate for the United States (U.S. dollar) from 2013 onwards (as data is readily available).

What Exactly is Inflation?

Inflation is defined as a general increase in the prices of goods and services within an economy, which consequently leads to a decrease in the purchasing power of money. Inflation can be influenced artificially by authorities like central banks or governments through controlling the money supply. The basic theory suggests that if more money is introduced into an economy without a corresponding increase in goods and services, the value of each unit of currency will decrease. The inflation rate is typically expressed as the percentage increase in prices over a 12-month period. Most developed countries aim to maintain a moderate inflation rate of around 2-3% through their fiscal and monetary policies to encourage economic activity.

Understanding Hyperinflation

Hyperinflation is an extreme and rapid form of inflation that quickly destroys the real value of a currency. It usually occurs when there’s a massive increase in the money supply without a significant rise in the gross domestic product (the total value of goods and services produced). Historical examples of hyperinflation include Ukraine in the early 1990s and Brazil from 1980 to 1994, where prolonged periods of hyperinflation rendered their currencies practically worthless. These economic crises caused severe hardship, forcing people to rely on more stable foreign currencies and hoard resources that could retain value, like gold. Another notorious example is Germany in the 1920s, where government stimulus measures involving printing money to cover World War I costs, coupled with massive war reparations (132 billion marks), led to economic collapse and shortages. With an excess of money chasing too few goods, prices doubled roughly every three days! The German Papiermark became so devalued that people used it as fuel for heating. The devastating effects of hyperinflation led to widespread poverty and emigration.

While hyperinflation is catastrophic, a moderate level of inflation from year to year is generally considered healthy for an economy. Because money is expected to have less purchasing power in the future, consumers are incentivized to spend rather than save excessively, which plays a crucial role in maintaining economic activity.

The Dangers of Deflation

Deflation, the opposite of inflation, is a general decline in the prices of goods and services. While it might seem beneficial at first glance, deflation is rarely welcomed by economists. In a deflationary environment, consumers are less motivated to spend because they anticipate that prices will be even lower in the future, meaning their money will have greater purchasing power. This slowdown in spending can put a significant brake on economic growth and even trigger a downward spiral. The Great Depression, for example, was accompanied by a deflationary spiral. The theory suggests that falling prices lead to lower profits for businesses, which in turn reduces spending and investment. This then leads to even lower prices, creating a negative feedback loop that can be extremely difficult to break and recover from.

Why Does Inflation Occur?

Macroeconomic theories attempt to explain the causes of inflation and the best ways to manage it. Keynesian economics, a dominant model for much of the 20th century and still influential today, posits that significant imbalances between the supply and demand of goods and services can lead to substantial inflation or deflation.

• Cost-Push Inflation: This type of inflation occurs when the costs of production for businesses increase. For example, if the price of oil rises due to political instability, the prices of many goods and services that rely on oil for production or transportation will also likely increase to cover these higher costs.
• Demand-Pull Inflation: This happens when the overall demand for goods and services in an economy exceeds the economy’s ability to produce them. With more money chasing a limited supply of goods, prices are driven upward.
• Built-in Inflation: Also sometimes called “hangover inflation,” this type of inflation is a consequence of past inflationary events whose effects persist in the present. It’s closely linked to both cost-push and demand-pull inflation, as these are major contributors to the current inflation rate. Built-in inflation is influenced by both subjective factors like inflationary expectations and objective factors like the price/wage spiral (where rising prices lead to demands for higher wages, which in turn can lead to further price increases).

The Monetarist View

A school of economic thought known as Monetarism, led by economists like Milton Friedman, argued that the money supply is the primary driver of inflation, rather than market forces alone. Monetarists believe that central banks, like the U.S. Federal Reserve, have a significant role in controlling inflation by managing the money supply (e.g., printing more money increases supply, selling government bonds decreases it). Their ideas are rooted in the Quantity Theory of Money, which states that changes in the money supply directly affect the value of currency. This is often represented by the Equation of Exchange:

$MV=PY$

Where:

• $M$ = Money supply
• $V$ = Velocity of money (the number of times a unit of currency changes hands in a year)
• $P$ = Price level
• $Y$ = Economic output of goods and services

Monetarists generally consider the velocity of money ($V$) and the economic output ($Y$) to be relatively stable compared to the money supply ($M$) and the price level ($P$). By assuming $V$ and $Y$ are constant, the equation supports the Quantity Theory of Money, suggesting a direct relationship between the money supply and the value (and thus price level) of currency.

In reality, most economies utilize a blend of both Keynesian and Monetarist policies, as both schools of thought acknowledge the validity of some aspects of the other’s theories. For example, Keynesians don’t entirely dismiss the role of money supply, just as Monetarists recognize that managing demand can also influence inflation.

How is Inflation Measured?

In the U.S., the Department of Labor is responsible for calculating the inflation rate each year. This is typically done by tracking the prices of a representative basket of goods and services over time. The costs of these items are compared at different periods, and the resulting figures are averaged and weighted using various formulas to produce the Consumer Price Index (CPI).

For example, to calculate the inflation rate between January 2016 and January 2017, you would first find the CPI for both months from the Bureau of Labor Statistics website:

• January 2016 CPI: 236.916
• January 2017 CPI: 242.839

Then, calculate the difference:

$242.839-236.916=5.923$

Finally, calculate the ratio of this difference to the initial CPI and multiply by 100 to get the percentage:

Thus, the inflation rate from January 2016 to January 2017 was approximately 2.5%. If the CPI for the earlier period is higher than the later period, the result indicates deflation rather than inflation.

Challenges in Measuring Inflation

While the example above simplifies the CPI calculation, accurately measuring the true inflation rate in a real-world economy can be quite complex.

One challenge lies in determining whether price changes in the basket of goods and services reflect genuine inflation or changes in quality. For instance, has the price of a computer increased due to inflation, or because of significant technological advancements that justify a higher cost?

Sudden and dramatic fluctuations in the prices of certain essential items, like oil, can also distort the overall inflation picture. A temporary spike in oil prices can lead to higher inflation readings but might not represent a sustained trend.

Furthermore, inflation rates can affect different demographic groups within a population in varying ways. For example, rising gasoline prices have a more significant impact on truck drivers than on individuals who work from home.

While CPI is the most widely used inflation index, other indices serve more specific purposes. For example, the Harmonized Index of Consumer Prices (HICP) was previously used in the European Union. CPIH is an adjusted version of CPI that includes housing costs like mortgage interest payments. CPIY excludes indirect taxes like VAT and excise duty, making it useful for analyzing inflation without the temporary impact of tax increases. CPILFENS (Consumer Price Index for All Urban Consumers Less Food and Energy) is considered a less volatile measure of inflation because it excludes the often fluctuating prices of food and energy, which can be influenced by factors like weather and global events, potentially giving a less accurate short-term view of underlying inflation.

Strategies to Potentially Beat Inflation

Inflation has the most significant negative impact on individuals holding large amounts of liquid cash that isn’t earning interest. Using our example inflation rate of 2.5%, a checking account with $50,000 would lose $1,250 in real value by the end of the year due to inflation. This illustrates why financial advisors often recommend spending or investing rather than simply saving cash in non-interest-bearing accounts. In an environment where moderate inflation is the norm, holding idle cash essentially guarantees a gradual erosion of its purchasing power.

Unfortunately, there’s no foolproof way to completely hedge against inflation. However, common strategies include investing in real estate, stocks, mutual funds, commodities, Treasury Inflation-Protected Securities (TIPS), art, antiques, and other assets. Each of these options has its own set of advantages and disadvantages, and investors often diversify across multiple asset classes to manage risk. Commodities and TIPS are frequently discussed in the context of inflation hedges due to their direct or indirect relationship with price levels.

• Commodities: Investing in raw materials or agricultural products like gold, silver, oil, and copper is a popular inflation hedge because these items have intrinsic value. During periods of high inflation, as the value of paper money declines, demand for commodities can increase their value. Gold, in particular, has historically been viewed as a reliable store of value and a hedge against inflation for centuries due to its finite supply and ease of storage.
• TIPS (Treasury Inflation-Protected Securities): In the U.S., TIPS are bonds issued by the U.S. Treasury specifically designed to protect investors from inflation. The principal of a TIPS adjusts proportionally to inflation, as measured by indices like the CPI, making them a relatively effective hedge during periods of rising prices. While they typically make up a small portion of most investment portfolios, investors seeking extra inflation protection can allocate more funds to TIPS. Because their performance is largely independent of the stock market, they also offer valuable diversification benefits. Additionally, the maturity of TIPS can be extended to potentially earn term premiums without the inflation risk associated with other types of bonds. Similar inflation-indexed bonds are offered by other countries, such as the UK’s index-linked gilts and Mexico’s Udibonos.