The inflation rate measures the change in prices. As prices rise at a faster rate, the inflation rate is higher and each dollar has less purchasing power. Measuring the inflation rate can help you predict how prices will change in the future and help you budget accordingly. When calculating the annual inflation rate over multiple years, you must account for the effects of compounding interest, so you may not simply divide the total inflation rate by the number of years.
In order to calculate annual inflation over multiple years, you must first locate the current inflation rate and then collect data on historical trends. With this information in hand, you begin calculating annual inflation over the designated time period.
Getting Started With the Calculations
Finding the current inflation rate is as simple as a little research. Pull data on each of the years you're monitoring from a reliable source like the Bureau of Labor Statistics. During 2017 and early 2018, the inflation rate hovered around the 2 percent mark, dropping as low as 1.7 percent and going as high as 2.3 percent. This may give you the baseline you need. However, if you want to measure the inflation rate based on prices you've paid for a specific product, you can easily do this by having the prices you've paid for that item over a particular time period.
Calculating the Inflation Rate
Divide the price at the end of the period by the price at the start of the period. For example, if you wanted to measure in the annual inflation rate of gas over eight years and the price started at $1.40 and went up to $2.40, divide $2.40 by $1.40 to get 1.714285714. Divide 1.0 by the number of years over which inflation takes place. In this example, divide 1.0 by 8 to get 0.125.
Raise the overall inflation rate to the power of the result using a calculator. Raising refers to using exponents. In this example, raise 1.714285714 to the 0.125th power to get 1.069696071. With a calculator, enter "1.714285714," push the exponent key (usually denoted with a "^" or a "x^y"), enter "0.125" and then push the equals key. When raising a number to a power less than 1, you get a number smaller than the original.
Take away 1 from the result to find the annual inflation rate. In this example, subtract 1 from 1.069696071 to find that the annual inflation rate equals 0.069696071, or about 6.97 percent.
Completing and Following Up
Over time, you can continue to monitor these numbers, determining if the prices you're paying locally are in line with the federal inflation rates being officially announced. You may find your own calculations give you valuable insights.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."