The base effect
Let’s assume that you paid $100 for an item in January 2021 and the price went up to $105 in February due to an unusual circumstance before reaching $110 in January 2022. In that case, annual inflation was 10% in January 2022. Now, if the price were to rise to $115 in February 2022, the annual inflation would come down to 9.5% for that period (reflecting the increase from $105 and $115). That doesn’t mean price pressures are softening. In fact, the $5 monthly increase in February 2022 is quite significant considering that the price rose by a total of $10 in the previous 12 months. However, because there was a big jump in the base number – February 2021 in that case – that is used to calculate the annual figure, the final outcome is lower than what it was in January.
How is annual CPI inflation calculated?
The Bureau of Labor Statistics (BLS) comes up with a final CPI figure each month after having conducted its Consumer Expenditure Survey. It compares this CPI value to the previous month and the previous year to find the percentage changes.
In the table below, CPI values in February 2021 and 2022 were 263.014 and 283.716, respectively. Hence, annual CPI inflation was 7.9% ((283.716 – 263.014) * 100 / 263.014).
Let’s take a look at the CPI value for April 2021. It rose to 267.054 from 264.877 in March. In 2022, the CPI value climbed to 289.109 in April from 287.504 in March. Despite that increase, the annual inflation in April 2022 declined to 8.3% from 8.5%. That is how the base effect could distort the data and be misleading at times. Although there still was a considerable increase in prices from March to April in 2022, it was at a relatively softer rate than it was a year ago, translating into a drop in annual inflation.