A Price Indexes and the CPI tells you the price level. The inflation rate tells you how fast it is changing, using Percent Increase and Decrease.
Key idea
$$\text{inflation rate} = \dfrac{\text{index this period} - \text{index last period}}{\text{index last period}} \times 100$$ Inflation: the price level rises. Deflation: the price level falls (negative inflation). Disinflation: inflation slows down, but prices still rise.
Why it works
The inflation rate is the slope of the price level, not its height. Think of a car's speed: slowing from 60 to 30 miles per hour is still moving forward. In the same way, when inflation falls from 6% to 2%, prices are still climbing, just more slowly. Only when the rate goes below zero does the price level itself fall.
Worked examples
Worked example: One year of inflation
The CPI rose from 250 to 260. What was the inflation rate?
- $\dfrac{260 - 250}{250} \times 100 = \dfrac{10}{250} \times 100 = 4\%$.
- Divide by the starting value, 250, not the ending value.
Answer: 4%
Worked example: Naming the pattern
The CPI is 100, then 106, then 110. Describe year 3.
- Year 2: $\dfrac{106 - 100}{100} \times 100 = 6\%$.
- Year 3: $\dfrac{110 - 106}{106} \times 100 \approx 3.8\%$.
- Inflation fell from 6% to about 3.8%, but stayed positive: disinflation. Prices still rose.
Answer: Disinflation
How much inflation is normal? The Federal Reserve aims for inflation of 2% a year over the longer run, measured with a close cousin of the CPI (the price index for personal consumption expenditures). A little steady inflation leaves room to cut interest rates in a slump; long stretches of deflation are rare and tend to come with weak economies.
Common mistake
Thinking falling inflation means falling prices. Disinflation means prices still rise, only more slowly; deflation means the price level falls. Check: look at the price index itself. Is it still going up? Then it is not deflation.
See it with real data: CPI inflation (year over year), with and without food and energy, on the Economic Data page.