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Friday, September 13, 2013

How to adjust an amount for inflation

"Back in my day, when I worked at McDonalds, I only made $2 an hour!"

"My first home only cost $30,000, and it was brand new."

"30 years ago, your mothers engagement ring cost me 1000 bucks."

Anecdotes about prices, wages and expenses across time periods are pretty common in day to day conversations about economics.

Whats more, these intertemporal comparisons are necessary for academic studies. Without looking at prices before and after a certain policy change, we can't take a guess at what the effects of these changes are.  Without examining wage rates of previous years, we can't know if this year is a good or bad year for a typical worker.

But there's that little hitch - inflation.  When they come up in conversation, comments like the ones above are always followed with a disconcerted glance into the air, a furrowed brow, and a "but today that would be...I don't know...twice as much?...a third more?"

Its actually incredibly easy to adjust a number for inflation.  I'll show you how in today's post (using the BLS's Inflation Calculator, pictured above), and explain a few caveats for using an inflation adjusted number.


To adjust a dollar amount for inflation, you have to first calculate a CPI, a Consumer Price Index.  

From there, its just a matter of multiplying the dollar amount you want to "inflate" by the CPI.  So think of CPI as a "multiplier" or "inflator," a number that gets the old amount into today's dollars.  
Official CPI figures are kept by the US Bureau of Labor Statistics.  Why labor stats?  They started keeping inflation data specifically to track changes in wage rates over the years.

The BLS Inflation Calculator

Now, you don't need to worry about putting together that CPI number yourself!  The BLS has made this excellent, handy-dandy "inflation calculator" available on their website.  

To use the calculator:
  1. Visit the applet's page - link here
  2. Fill in the blanks in the sentence (ex. $100 in 1950, has the same buying power as $904.80 in 2010.)
That easy!

Want to know what tuition REALLY cost your parents?  What your grandfather shelled out for his first car would've felt like today?

So ask a older relative or friend about prices in the past, fix them for inflation, and see what you find!  As always, share any noteworthies in the comments below.

Interpreting an "Inflation Adjusted" Figure

There's a few things you need to understand about that CPI multiplier in order to really understand what you're looking at when you look at an inflation adjusted figure.

The BLS constantly records the average price, nation wide of a set of about 8,000 goods, services and utilities - basically "all the stuff people buy."  Stuff like food, housing, clothes, transportation, medical care, recreation, education, communications, and personal services (like haircuts or gym memberships).  For a fuller list, see page 50 of this document.

This set of stuff is called the "basket," and its cost is tracked month to month throughout 38 metropolitan areas.  If the cost of the basket goes up, say, 1% between 1985 and 1986, then there has been 1% inflation in those 12 months.

So what CPI is really adjusting for is the power of a dollar itself.  It answers the question how far does a dollar go in this year compared to how far dollars go in that year.

But is a it an art or a science?  The calculations are obviously just straightforward math.  That's the science.  

But the methodology going into it, and the decisions made about what goes into the basket, and what weight to assign those items...someone at the BLS has to make those choices.  There's an element of discretion involved.  And therein lies the art.

There's actually quite a few CPI's published by the BLS.  Different ones for different purposes.  There's the:
The methodologies and baskets vary somewhat between the CPI's, but their general gist and use are the same.

So again, call your dad, and ask what beer cost in the 70s.  Find out what grandma used to pay for butter.  Share with us what you find.  You'll be surprised by what you find - and the line of conversation it'll start you two on!

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