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Rates · Liquidity · Scarcity · Credit · Power · 2026-10-29
CONCEPTS · Inflation

Base Effect

A year-over-year comparison quietly drops the same month last year out of the arithmetic. That is why the headline can fall while the prices on the shelf keep rising.

The base drops out of the frame

A year-over-year inflation rate compares this month's price index with the index for the same month a year ago. The comparison is a reporting habit, and it has a consequence: whatever happened in that base month stops influencing the number, then disappears entirely once a year has passed.

If the base month was ordinary, this is harmless. If it carried a shock - a spike, or a fall - the headline will move next year for the sole reason that the shock is no longer in the denominator. That mechanical movement, produced by arithmetic rather than by new price pressure, is the base effect.

A sequence you can check by hand

SAME CLIMB - FALLING HEADLINE+10%+5%+2.5%Y1 100Y2 110Y3 115.5Y4 118.4SLOWER CLIMB - THE LEVEL NEVER FALLS

Work it by hand. Suppose the index is 100 1yr and 110 the next: that is 10% inflation. A year later it reaches 115.5, which is 5% on 110. A year after that it reaches 118.4, which is about 2.5% on 115.5. The headline fell from 10 to 5 to 2.5 while the index rose at every step.

Falling headline, rising prices

Every step in that sequence is an increase. The percentage fell because the base month got bigger, not because anything got cheaper. Reported as inflation falls this is correct; reported as prices fall it is wrong, and the two get mixed up constantly.

Use the idea before you react to any year-over-year print: ask what the base month did, and look at the level rather than the rate. A falling rate alongside a rising level is disinflation, and the same arithmetic runs in reverse when a quiet base month makes this year look worse than it is.

IF YOU REMEMBER ONE THING
DefinitionA move in a year-over-year rate caused by the base month dropping out of the comparison, not by any new price change.
MechanismThe comparison divides by last year's index. When that base was a spike, this year's rate falls even if prices climbed steadily.
CheckRead the level, not only the rate. 100 to 110 to 115.5 to 118.4 is +10%, +5%, +2.5% with prices rising throughout.

Related: Disinflation · Inflation Expectations · PCE

Next: Inflation Expectations