Inflation Update

Recall that here at Financology, our working definition of inflation is a decline in the overall market value of the currency. Prices rise because it takes more of these smaller currency units to buy the same stuff.

It’s common to portray inflation as an upsloping line of prices, but that puts a misplaced emphasis on the things being bought with the currency, when it’s the currency itself that’s changing.  So the truth is better illustrated by a downsloping line of the value of the currency. With that in mind, below is the latest update of the Financology Dollar Index.

From the data plotted in the chart, we can calculate a rate of inflation.   As we’ve pointed out before though, there is no unique answer.  Without getting into forecasting, data can never tell us what the rate of inflation is, only what it has been … and for this purpose some time frame has to be selected.  For example, we can calculate a year over year rate, an average over the past four years, an annualized rate over the past quarter, etcetera. Our current year over year rate is 16.61%. Because it compares the value of the dollar to that of a year ago, after the value rose in a rush to cash during the corona crash, it reflects a so-called “base effect” and is not representative of the true trend.

We can use an alternate method that finds the difference between the current value of the dollar and an exponential moving average with a time constant introducing a one year delay. Because the “base” is not localized at one year ago but instead spread over the entire history of the data series, we can bypass this base effect.

This method gives us an annualized rate of inflation of 12.40%.