Inflation Adjustements and the Base Year

When converting from nominal to real variables it is important to determine in what dollars the real variables should be expressed. 1994, 1987, 1967 are all possibilities. In most cases the best solution would be to express the real variables in current dollars, the dollars your audience is likely to be familiar with. For example, consider the data below on average weekly earnings for the period 1980 to 1994. If we followed the procedure outlined above we would generate the Real variable, something virtually impossible to explain. Two alternative constructs appear in the following columns. In the Real (80$) column we have the value of real wages expressed in terms of 1980 dollars which is derived by taking the Real column and multiplying it by the CPI in 1980 [Ex. in 1985 $229.04 = $299.09/107.6*82.4]. The Real (94$) column, meanwhile, expresses real wages in terms of 1994 dollars and is derived by multiplying the Real column by the CPI in 1994 [Ex. in 1987 $403.55 = $312.50/113.6*146.7].

	CPI	Nominal	Real	Real (80$)	Real (94$)
1980	82.4	$235.10	$2.85	$235.10	$418.56
1981	90.9	$255.20	$2.81	$231.34	$411.86
1982	96.5	$267.26	$2.77	$228.21	$406.29
1983	100	$280.70	$2.81	$231.30	$411.79
1984	103.9	$292.86	$2.82	$232.26	$413.50
1985	107.6	$299.09	$2.78	$229.04	$407.77
1986	109.6	$304.85	$2.78	$229.19	$408.04
1987	113.6	$312.50	$2.75	$226.67	$403.55
1988	118.3	$322.36	$2.72	$224.53	$399.75
1989	124	$334.24	$2.70	$222.11	$395.43
1990	130.7	$345.35	$2.64	$217.73	$387.63
1991	136	$353.98	$2.60	$214.47	$381.83
1992	140.5	$363.95	$2.59	$213.45	$380.01
1993	144.5	$373.64	$2.59	$213.07	$379.33
1994	146.7	$375.70	$2.56	$211.03	$375.70

Does it matter which variable you decide to use? In one sense, no. All three of these columns provide equivalent measures of real wage growth. If you do the math you will find that for all three measures, wages decline by 10 percent during the period. Where they differ is in the interpretation. One possibility would be to describe the fact that workers who earned $235.10 in 1980 are currently earning the equivalent of $211.03 1980 dollars in 1994. A second option would be to say that the workers earning $375.70 a week in 1994 have seen their earnings fall from $418.56 since 1980. Which you choose depends on which you think your audience would best be able to relate to.