Accounting for Inflation – Deflators, or “What Does ‘Prices in Real Terms’ Actually Mean?”

“How much would £85.32 million in 2011-12 prices have been worth in 2007-08?” We see this sort of statement in the news all the time, either in reports about the effects of inflation, or as a way of making historical comparisons, so there must be a simple way of calculating the result.

The answer, it seems, comes in the form of “GDP Deflators“, tables of which are published quarterly (for example, see the UK’s GDP deflators at market prices, and money GDP: June 2014 (Quarterly National Accounts)).

The gov.uk published document How to use the GDP deflator series: Practical examples.

Deflation tables have the following form:

deflator_table

Several examples of common calculations are shown:

deflator_example1

deflator_example2

deflator_example3

The House of Commons Library also publishes a Statistical Literacy Guide – How to adjust for inflation with a little more detail. It also qualifies the meaning of “prices in real terms” as constant prices, that is, prices where inflation has been taken into account (deflated).

The corollary of rising prices is a fall in the value of money, and expressing currency in real terms simply takes account of this fact. £100 in 1959 is nominally the same as £100 in 2009, but in real terms the [nominal] £100 in 1959 is worth more because of the inflation over this period. Of course, if inflation is zero, then nominal and real amounts are the same.

Often we want to express a series of actual (nominal) values in real terms. This involves revaluing every annual figure into a chosen year’s prices (a base year), effectively repeating the stages above on a series of nominal values and using the same base year (year x above) for all. … Once done, changes can be calculated in percentage or absolute terms. The choice of base year does not affect percentage change calculations, but it will affect the absolute change figure, so it is important to specify the base year.

The Commons Library Standard Note also clarifies that the idea that the process of inflating figures relates to the notion of purchasing power – for example, what would a pound in 2005 be worth today?

purchasing power

So what other “everyday economics” terms are there that I don’t really understand? “Seasonal adjustment” and “seasonally adjusted figures” for one.. But that will have to be the subject of a further post.

PS for deflators for other countries, the OECD aggregates a few: GeoBook: Deflators.

PPS see also @mcgettigan on Student loan repayments & ‘present value’ (h/t Joss Winn). Are there standard calculations that consider if you make actual (at the time) payments of £x_m per month, m, eg grabbed from your bank statements, and then sum the “real terms” values of those according to some baseline? Would that sort of calculation even make sense?