Inflation Calculator

Inflation Calculator

An inflation calculator is an online tool which allows you to calculate the effects of inflation on the purchasing power of money over time. It shows how rising prices reduce the value of money.

Inflation calculators can help you estimate the future cost of an item or service, adjust prices for inflation, and determine the real rate of return on an investment after factoring in inflation. This beginner's guide will explain everything you need to use an inflation rate calculator.

What is Inflation?

Inflation implies the general upward price movement of goods and services over time. It is measured by the inflation rate, which indicates the percentage change in prices over a given period, usually one year.

For example, if the inflation rate is 5% in a year, the average price of goods and services has increased by 5% over the last 12 months. This reduces your purchasing power so you can buy less with the same amount of money.

Various economic factors like demand-pull inflation and cost-push inflation cause inflation. Some amount of inflation is considered normal in a growing economy. However, high inflation rates can negatively impact consumers and the broader economy. It is very important to be aware of how to calculate inflation rate.

What is Inflation Calculator?

An inflation calculator is a tool used to measure the effect of inflation on the purchasing power of money. It allows you to compare the relative value of money from one period to another.

Inflation rate calculator work by adjusting prices for inflation using the Consumer Price Index (CPI) - a standard measure of inflation issued by the government. The CPI tracks changes in the prices paid for goods and services like food, housing, apparel, transportation, etc.

To use the inflation calculator, you input an amount, select the start and end years, and the tool automatically adjusts the dollar amount for inflation, showing how much the same goods would cost in today's dollars.

Benefits of Inflation Calculator in India

Here are some of the key benefits of using an inflation calculator in India:

• Plan Household Budgets: An inflation calculator helps plan budgets more accurately for the future by factoring in the impact of rising prices. This allows you to allocate funds accordingly.
• Purchase Decisions: You can use the calculator to assess whether big-ticket purchases like cars and homes will be affordable in the future based on expected inflation.
• Returns on Investment: It helps determine the real rate of return on investments after discounting for inflation. This shows the proper growth of your money.
• Salary Expectations: A rupee inflation calculator can provide historical context to determine fair salary raise expectations and negotiations.
• Compare Prices: You can use it to compare current and historical prices of commodities to make informed purchase decisions.
• Savings Goals: It helps assess the future value of current savings towards goals like retirement and child's education based on inflation.

How is Inflation Calculated?

There are two main ways inflation is measured:

1. Consumer Price Index (CPI): The Consumer Price Index tracks consumers' prices for goods and services like food, medical care, apparel, etc. CPI is calculated by taking price changes for each item in the predetermined basket of goods.

2. GDP Deflator: The GDP deflator measures inflation by comparing the nominal GDP (not adjusted for inflation) with real GDP (adjusted for inflation). The deflator captures inflation arising from all sectors of the economy.

The Reserve Bank of India uses CPI data to measure inflation for policy formulation and targeting. The most common inflation indices used are:

• CPI Combined
• CPI Industrial Workers
• WPI (Wholesale Price Index)
• Inflation Calculation Formula
• The most common inflation calculation formula is:

Inflation Calculation Formula

The formula for calculating inflation is -
Inflation Rate = (Current CPI - Previous CPI) / Previous CPI x 100
Here, CPI refers to the Consumer Price Index. Current CPI is for the current period, and the Previous CPI is for the earlier period.

For example:
Here is an explanation of the inflation calculation formula with a proper example:
The inflation rate is calculated using the following formula:
Inflation Rate = (Cost of Goods in Current Year - Cost of Goods in Base Year) x 100 / Cost of Goods in Base Year
Let's understand this with an example:
Suppose a loaf of bread costs Rs. 20 in 2015 (the base year). In 2020, the same loaf of bread cost Rs. 25.
To determine the rate of inflation between 2015 and 2020, we can plug the values into the inflation rate formula:
Cost of a loaf of bread in 2020 (Current Year) = Rs. 25
Cost of a loaf of bread in 2015 (Base Year) = Rs. 20

Plugging this into the formula:
Inflation Rate = (Cost in Current Year - Cost in Base Year) x 100 / Cost in Base Year
= (25 - 20) x 100 / 20
= 5 x 100 / 20
= 25%

Therefore, the inflation rate over the 5 years from 2015 to 2020 is 25%, indicating the price of the loaf of bread became 25% more expensive over this duration.
This demonstrates how the inflation formula can calculate actual inflation rates based on changes in the cost of goods over time. The choice of base year sets the reference point for price changes.

How Does Inflation Affect Your Savings?

Inflation slowly eats away at your savings over time. Here is how it impacts savings:

• Reduces Purchasing Power: Inflation reduces what you can buy with your savings in the future. Goods and services will cost more.
• Diminishes Real Returns: Your investment returns are reduced after factoring in inflation. The real rate of return is lowered.
• Requires Larger Corpus: You need to accumulate a higher corpus for goals to maintain the same purchasing power in the future.
• Long-Term Impact: Inflation compounds over long periods, significantly reducing wealth. Retirement savings are the most impacted.
• Encourages Immediate Spending: High inflation incentivizes immediate consumption rather than future spending. This impacts savings.

To beat inflation, it is advisable to invest savings in assets that appreciate above inflation like equities, real estate etc.

How to Overcome Inflation?

Here are some tips to overcome rising inflation:

• Invest in equities through mutual funds, stocks etc. as equity returns tend to beat inflation over the long run.
• Invest in inflation-indexed bonds or securities that pay a guaranteed inflation-adjusted return.
• Invest in real assets like property gold/silver that appreciate during inflation.
• Avoid keeping excess cash savings in the bank account as interest rate is lower than inflation.
• Plan budgets, savings and investments keeping sufficient buffer for expected inflation.
• Shop wisely, look for discounts, buy generic brands, and procure seasonal produce to lower costs.
• Look for ways to increase your income like freelancing, investing in skills etc. to offset reduced purchasing power.
• Make big ticket purchases earlier before prices escalate further due to inflation.

Conclusion

An inflation calculator is a useful tool to understand the impact of inflation on monetary values over time. It provides key insights for financial planning and spending decisions. This guide covers the basics of using a rupee inflation calculator for effective personal finance management.