What is an Inflation Index?

To simplify the task of interpreting the price levels for more realistic and complex baskets of goods, economists typically report the price level in each period as an index number, rather than as the dollar amount for buying the basket of goods. Economists create price indices to calculate an overall average change in relative prices over time.

Indexing may seem like an obviously useful step. After all, when individuals, firms, and government programs are indexed against inflation, then people can worry less about arbitrary redistributions and other effects of inflation.

However, some of the fiercest opponents of inflation express grave concern about indexing. They point out that indexing is always partial. Not every employer will provide COLAs for workers. Not all companies can assume that costs and revenues will rise in lockstep with the general rates of inflation. Not all interest rates for borrowers and savers will change to match inflation exactly. However, as partial inflation indexing spreads, the political opposition to inflation may diminish. After all, older people whose Social Security benefits are protected against inflation, or banks that have loaned their money with adjustable-rate loans, no longer have as much reason to care whether inflation heats up. In a world where some people are indexed against inflation and some are not, financially savvy businesses and investors may seek out ways to be protected against inflation, while the financially unsophisticated and small businesses may suffer from it most.

Related Topics

• Inflation
• Core Inflation
• Cost Push Inflation
• Demand Pull Inflation
• Wage Push Inflation
• Inflation Spiral (Wage-Price Spiral)
• Agflation
• Basket of Goods and Services
• Indexing and Index Number
• Base Year
• Consumer Price Index
• Substitution Bias
• Quality / New Goods Bias
• Core Inflation Index
• Producer Price Index
• International Price Index
• Employment Cost Index
• Buying Power Index
• Breakfast Index
• Employment Cost Index
• Producer Price Index
• Capital Goods Price Index
• Farm (Agricultural) Price Index
• Harmonized Index of Consumer Prices
• Repeated Sales Method (Real Estate)
• GDP Deflator
• Deflation
• Pigou Effect
• Hyperinflation (Economics)
• Biflation
• Inflation and Redistribution of Purchasing Power
• Inflation Blurs Price Signals
• Inflation Affects Long-Term Planning
• What are the Benefits of Inflation?
• Indexing and Index Number
• Cost of Living Allowance
• Adjustable Rate Mortgage