Inflation

Inflation:= change in the price of the basket of goods [= a representative sample of GDP]

$$I.R.=\frac{P_t-P_{t-1}}{P_{t-1}}$$

• Interest rate $\propto$ inflation rate [← explained later]

• Historically, price of capital equipment (relative to consumption goods) have gone down …but the price of housing have gone up → thus must know inflation of what?

  • Total Inflation: CPI measured using the representative basket of goods
  • Core Inflation: represents the long run trend in the price level.
    • In measuring long run inflation, transitory price changes should be excluded.
    • ⇒ Exclude items frequently subject to volatile prices, like food and energy
    • i.e. the change in Core CPI

• Inflation data is often shown as Year-over-Year (YoY) which means you can’t compound