Inflation Measurement and Adjustment

If you roll your eyes when you hear an elderly person talk about how everything used to be so much cheaper back in the day, then you probably understand “inflation.”

Inflation is a given in our capitalist economy today, which means people expect prices (and ideally, wages) to go up about 2% each year, give or take. While prices appear to be rising, that doesn’t necessarily mean things are actually getting more expensive, since your income is also probably rising along with inflation.

To actually figure out the value of what your money can buy at any given time, you have to measure and adjust for inflation. In the U.S., inflation is usually measured by the Consumer Price Index (CPI) and Producer Price Indexes (PPI). These are two general indexes that measure the prices of what things (groceries, gas, clothing, etc.) cost over time. Basically, they’re really large surveys taken regularly to track changes in prices of general goods over time.

For instance, since 1985, the CPI has risen about 115%, while college costs have risen about 500%. That means college is a lot more expensive in real value than it was in the late ‘80s after adjusting for inflation. It also means you can tell your older relatives who complain about millennials complaining about college debt to suck it, because it’s not possible to pay off college with a side job like they did.

If you’re an investor, you’ll want to calculate the inflation-adjusted return of your gains to understand the real value you’ve gained. If you simply look at the numbers in nominal terms without adjusting for inflation, you won’t be getting an accurate picture of how much money you’ve really made. Cha-ching.