How to Calculate Inflation Rates

Regardless of which inflation rate you’re talking about, inflation is the pace at which prices rise. If the inflation rate is 2% a year, then prices are rising on average by 2% every year. But this doesn’t mean that every price in the economy is rising at that rate. Prices of some things might be rising faster than 2%, while prices of other things are rising more slowly or might even be falling. The average of all these price changes is the inflation rate.

If the rate of inflation falls, that doesn’t mean that prices are falling. It just means prices are rising slower. Only if the inflation rate is negative do prices fall. “Disinflation” is the word economists use to describe an inflation rate that is falling but still positive. “Deflation” is used when the inflation rate is negative, and prices are actually falling.

Deflation is most often seen when the economy is in recession, and often takes the form of heavy discounting and fire sales by stores and other companies that are doing their best to stay in business. In the U.S., deflation doesn’t usually last for long.

There are lots of different prices in the economy, and therefore lots of different types of inflation rates. There are also different ways of calculating similar types of inflation.

Consumer Price Index (CPI): This is the best-known and most widely used inflation measure. This is the rate at which consumer prices are rising. The CPI is a “basket” of consumer goods and services that represents what Americans typically buy on a monthly basis. Because the Bureau of Labor Statistics (BLS) monitors changes in the prices of these goods and services in mostly urban areas, you may also see CPI referred to as CPI-U. The BLS calculates the index and publishes it monthly.¹

It is usually quoted as a percentage rise “per annum.” So, for example, if the CPI inflation rate is 2% per annum, that means that consumer prices are, on average, rising by 2% every year. The CPI inflation rate is used to determine Social Security benefit increases, and is typically the reference rate for inflation-protected investments such as indexed government bonds and inflation swaps, which people can use to protect their savings against inflation.

Personal Consumption Expenditures (PCE): An alternative to the CPI inflation rate is the PCE inflation rate, which is calculated by the Bureau of Economic Analysis (BEA).² The PCE inflation rate is calculated in a similar way to the CPI inflation rate, but its basket of goods and services is broader. It tends to be slightly lower than the CPI inflation rate.

Both CPI and PCE inflation rates have two versions: the so-called “headline” rate, which is the one you will see in the press, and the “core” rate, which strips out some consumer goods and services whose prices tend to move around a lot, such as gasoline. One part of the Federal Reserve’s dual mandate is price stability. Price stability means that inflation remains low and stable over the long term.³ The U.S. Federal Reserve has targeted an inflation rate of 2% as measured by the Personal Consumption Expenditures (PCE) Price Index.⁴

Other types of inflation rates that you may see quoted in the news include:

The BLS publishes monthly and annual CPI inflation rates—in other words, the change in prices since last month or last year. But you can use the CPI to calculate the inflation rate between any two dates. For example, let’s imagine it is December 2022 and you want to know what the CPI inflation rate has been for the past two years—since December 2020. Here’s how to make that calculation:

Note that this data was taken from the BLS, looking at the: Historical Consumer Price Index for All Urban Consumers (CPI-U): U.S. city average, all items, by month:⁵

Note that this is not an annual figure. If you want to know the average annual rate during that time, you need to divide this by the number of years: 13.94% / 2 = 6.97%.

You can use the same calculation method to work out other inflation rates from their indexes.