Question

5. What is meant by a base year? Why do we need one? What base year is the USA economy using, even though it is 2015?

Answer 1

Concept of Base Year:

A base year refers to the first year on the basis of which comparison of an economic index is done. These economic indices can vary from Consumers’ Price Index (CPI), Producers’ Price Index (PPI), Employment Index etc. Since calculation of indices falls under time series data analysis, the base year can be considered as the starting point which builds the foundation for COMPARISON of each of these indices.

Need for Base Year:

Any kind of comparison for any analysis requires a benchmark. If one wants to compare changes in price levels, then it has to be done on the basis of another constant price level. A measure of inflation based on current prices only will not show the accurate increase/decrease in inflation. Thus one has to be very careful in choosing the base year as the “representative” of an ideal economy where no external shocks like natural disaster etc have taken place to adversely affect its economic performance.

Thus, without a base year, appropriate assessments in changes of economic indices like CPI, PPI etc on a year to year basis, cannot be calculated. For easy comparison purposes, the base year price index is pegged to 100. The formula for Current Year Index is given by the ratio of current year price to base year price and is expressed in percentage. This means that if the current CPI is 140%, then it actually implies that there has been a 40% rise is CPI in comparison to the base year.

US Economy’s Base Year:

Even though it’s 2015, the US economy’s Bureau of Labor Statistics which calculates the CPI, uses 1982-1984 as the base year. This chained base year refers to relevant economic data from years 1982, 1983 and 1984, converted into real terms and pegged to 100. USA is a huge economy to look after and the easiest and most convenient way of calculating indices is by using 1982-1984 as the base year. This is because 1982-1984 has met all the cut offs required to be the ideal base year for USA. Another reason for using that base year is because during 1982-1984, methodologies for calculating CPI had been revolutionized and till date, the same methodologies are being followed.