Inflation rates are the measurements of how much prices increase from one year to another. They are important to track because they affect the purchasing power of people and businesses. People who rely on fixed incomes and pensions often lose purchasing power when inflation is high, and businesses can suffer because they have to keep increasing their prices to cover costs.
In order to calculate a rate of inflation, you have to take a look at what is called a price index. These are based on what is considered to be a “basket” of goods and services that average consumers purchase. Each item in the basket is given a weight based on how many of them are purchased by the average consumer. The sum of all the weighted items is then compared to the sum of all the weighted items in the same period last year and the percentage change is calculated. In the United States, this is how the Consumer Price Index (CPI) is calculated and reported each month.
The CPI only goes back to 1913, so in order to determine an inflation rate before this date, analysts will use an existing index and subtract it from a comparable index using data from 1800 or earlier. They will then use the result as the starting point for their calculations, and compare that figure to future inflation rates.
Typically, businesses that have to continually raise their prices as a result of inflation will find it harder to stay competitive and may shut down. This can lead to a loss of jobs and a decrease in economic activity. However, for those who own assets that appreciate in value or earn higher interest rates than cash, they can potentially benefit from inflation.