The base effect is a mathematical effect that originates from the fact that a given percentage of a reference value, is not the same as the

absolute difference The absolute difference of two real numbers x and y is given by , x-y, , the absolute value of their difference. It describes the distance on the real line between the points corresponding to x and y, and is a special case of the Lp distance fo ...

of the same given percentage of a much larger or smaller reference value. E.g. 1% of a

GDP Gross domestic product (GDP) is a monetary measure of the total market value of all the final goods and services produced and rendered in a specific time period by a country or countries. GDP is often used to measure the economic performance o ...

of is not equal to 1% of GDP of in terms of

. The reference value is common called a base year in economics. A low base effect is the tendency of an absolute change from a low initial amount to be translated into a larger percentage change, while a high base effect would be the tendency of an absolute change from a high initial amount to be translated into a smaller percentage change. Because of the base effect percentages in

time series analysis In mathematics, a time series is a series of data points indexed (or listed or graphed) in time order. Most commonly, a time series is a sequence taken at successive equally spaced points in time. Thus it is a sequence of discrete-time data. ...

can be misleading, in particular when percentages are compounded annually over a period of many years. A high base effect can mislead because of decreasing percentages even while the underlying

is increasing over time as much as the measured value or population increases over time. Also, a low base effect can mislead because of increasing percentages even while the

is decreasing over time as much as the measured value or population decreases over time. A base effect is closely related to a base year, which serves as a reference point to normalize rates of change, similar to the function of a denominator in comparisons. When inflation is measured with a

price index A price index (''plural'': "price indices" or "price indexes") is a normalized average (typically a weighted average) of price relatives for a given class of goods or services in a specific region over a defined time period. It is a statistic ...

different formulas produce different results because of the base effect. E.g. Paasche versus Laspeyres price indices. Because of the problems, in particular with headline inflation, that arise from volatility in prices

core inflation Core inflation is a type of inflation measure which seeks to represent the underlying long-run trend of aggregate price levels in the economy. This is achieved by removing certain items exhibiting short-term significant price fluctuations wit ...

is used as an additional indicator of the development of inflation. A lot of different methodologies can be used to correct for the base effect in computations of economic growth, and are often used in financial market analysis. A base effect relates to

inflation In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...

when in the corresponding period of the previous year. If the inflation rate was too low in the corresponding period of the previous year, even a smaller rise in the

Price Index A price index (''plural'': "price indices" or "price indexes") is a normalized average (typically a weighted average) of price relatives for a given class of goods or services in a specific region over a defined time period. It is a statistic ...

will arithmetically give a high rate of inflation now. On the other hand, if the price index had risen at a high rate in the corresponding period of the previous year and recorded high inflation rate, a similar absolute increase in the price index now will show a lower inflation rate now. An example of the base effect:
:The Price Index is 100, 150, and 200 in each of three consecutive periods, called 1, 2, and 3, respectively. The increase of 50 from period 1 to period 2 gives a percentage increase of 50%, but the increase from period 2 to period 3, despite being the same as the previous increase in absolute terms, gives a percentage increase of only 33.33%. This is due to the relatively large difference in the bases on which the percentages are calculated (100 vs 150).

References

{{DEFAULTSORT:Base Effect (Inflation) Data analysis Inflation

See also

References