While dining with my wife and four friends recently at Reid’s Apothecary in downtown Brunswick, a question and insight came my way.
“Why is inflation measured as a percentage? Percentages are often deceiving.”
The question and insight are serious, as is the person who delivered them. The person – let’s call her “Jeannie,” to protect the names of the innocent – is a top-flight number-cruncher who can solve calculus problems in her head while juggling chainsaws.
She continued. “Take someone who was spending $100 a week on groceries. Soon, she’s paying $10 more for the same groceries. From $100 to $110 is a 10% increase.
“Soon, she’s paying another $10 more for the same groceries. From $110 to $120 is a 9.1% increase.
“To economists, the decrease in the percentage increase means inflation is falling. But to our grocery shopper, whose bill went up by $10, and then another $10, inflation isn’t falling. Are you going to tell her she’s wrong?”
Now, this is my kind of dinner conversation.
The idea of percentage change was prompted by this question: when the numerical value of something of interest – prices, blood pressure, bowling score, etc. – changes over a stretch of time, how can we gauge whether the change is large or small?
Consider. Suppose “Jeannie” wants to know how much real GDP – the inflation-adjusted value of U.S. production – changed from 2021 to 2022. She retrieves the figures: $21,408 billion in 2021 and $21,822 billion in 2022.
She immediately notices a paradox. The $414 billion increase in real GDP means the U.S. economy produced $414 billion more in goods and services in 2022 than it did in 2021. $414 billion is a lot of goods and services. But a change from $21,408 billion to $21,822 billion appears less impressive.
The second part of the paradox is what percentage change is about. A percentage change expresses the change from an initial value relative to the initial value itself. The calculation is: ((more recent value minus initial value) divided by initial value) times 100.
$414 billion is a big number, but it’s a modest 1.9% increase from $21,408 billion. (Note: the average annual growth rate of U.S. real GDP over the past 20 years is 2.1 percent.)
Percentage change has properties that can, indeed, make it deceptive. The same percentage change will mean a small numerical change if the initial value is small and a large numerical change if the initial value is large. The same numerical change will mean a large percentage change if the initial value is small and a small percentage change if the initial value is large.
The key: pay close attention to the initial value.
Now, to “Jeannie’s” question at Reid’s. Inflation is measured as a percentage change because it’s the clearest, most straightforward way to measure inflation. Inflation is a persistent increase in prices in general. Measuring prices in general requires constructing a price index, such as the Consumer Price Index (CPI). Constructing the CPI is a complex process. See for yourself at bls.gov/opub/hom/cpi/.
The process culminates in a new CPI. The most recent CPI, for August, is 306.269. The CPI for August 2022 is 295.320. The increase of 10.949 means prices in general were higher in August 2023 than they were in August 2022. That’s inflation.
We could leave it at that. But that would leave us with an unanswered question: how much inflation is that?
This much: (10.949 divided by 295.320) times 100 equals 3.7%.
That’s down from the June 2021 to June 2022 post-pandemic peak of 8.9%. The decrease in inflation means prices are still increasing, but not as much as they were.
Reg Murphy Center