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A3. How do I adjust for the effects of inflation?

Economic analyses often use data from two or more calendar years. Price inflation causes the value of a dollar to fall over time, and so the same dollar amount in two different years will usually represent different amounts of purchasing power. To counteract this problem, analysts typically adjust dollar figures to account for inflation. Figures that have not been adjusted for inflation are said to be in 'nominal dollars,' while those that have been adjusted are in 'real dollars.' This FAQ response describes how to adjust for inflation so that dollar values are expressed in terms of a single year's currency.

Inflation adjustments are made using price indices. Each index consists of numbers representing the price level in each year relative to a base year. Some indices have values that correspond to shorter periods as well, such as months or quarters. What distinguishes the indices is how the price levels are established.

To correct for inflation the analyst selects a base year. The goal is to adjust all dollar figures so that they are expressed in terms of dollars in that year. Often the base year is chosen to be the current year or the final year of study data. For example, suppose that you adjust for inflation using the Consumer Price Index for all urban consumers. To express a 2000 cost in 2005 dollars, simply multiply the cost by the 2005 index and divide by the 2000 index. The relevant index values are 113.4 for 2005 and 100.0 for 200. If the cost were $20 in 2000, this would be the calculation:

$20.00 x (113.4/100.0) = $20.00 x 1.1342 = $22.68

Converting costs to 'real dollars' allows us to compare costs incurred in different years. For example, which is more expensive in 2005 dollars: A, which costs $20 in 1995, or item B, which costs $23 in 2000? Using the CPI for all urban consumers, item B is more expensive in real terms: it costs $26.09 in 2005 dollars, whereas item A costs only $25.63 in 2005 dollars.

One can convert costs to any year for which a price index exists. The base year does not affect which good is more expensive. If A is more costly than B in one base year, it will be more costly in terms of any other base year.

Which Index?

At HERC we often use the U.S. Consumer Price Index for all urban consumers. Values for this index tell what a market basket of consumer goods that cost $100 in 1983 would cost in the year in question. It quantifies the erosion of purchasing power by inflation. If most of the costs you are considering derive from staff, as is often the case for health care, then the general CPI is appropriate. The chain-weighted CPI is likely to be more accurate than the standard CPI, but it has only been figured since 2000.

We do not recommend using the Consumer Price Index for medical care. It analyzes changes in the cost of providing a day of stay and an outpatient visit. In recent years fewer but more expensive days of stay and visits are needed to treat an illness. This change is captured by the index without considering the change in productivity, overstating the increase in cost. Other faults of the medical care CPI are its reliance on list prices and the weighting of component medical care goods and services based on consumers out-of-pocket costs rather than overall health care expenditures. Berndt et al. (2000) provide a more through discussion of shortcomings in the medical care CPI and propose a fundamental reform of it.

Index Values

The table below shows the 2000-2009 index values for three common inflation indices used for health care research: the Consumer Price Index (CPI) for all urban consumers; the chain-weighted CPI for all urban consumers; and the Gross Domestic Product (GDP) implicit price deflator. The table has three columns of figures for each index. The first column uses the base year employed by the federal agency that makes the index; that year varies across indices. The second column shows the same numbers converted to a base year of 2009. The third column shows the percentage change in the index from year to year.

Table 1. Inflation Index Values    
Year CPI
1982-84
= 100
CPI
2009
= 100
%
Change
Chained
CPI
1999
= 100
Chained
CPI
2009
= 100
%
Change
GDP Implicit
Price Deflator

2005

= 100
GDP Implicit
Price Deflator

2009

= 100
%
Change
2009 214.537 100 -0.4 124.353 100 -0.1 109.615 100 0.9
2008 215.303 100.357 3.8 124.433 100.064 3.7 108.619 99.091 2.2
2007 207.342 96.646 2.8 119.957 96.465 2.5 106.296 96.972 2.9
2006 201.6 93.970 3.2 117.0 94.087 2.9 103.257 94.200 3.2
2005 195.3 91.033 3.4 113.7 91.433 2.9 100.000 91.228 3.3
2004 188.9 88.050 2.7 110.5 88.860 2.5 96.770 88.282 2.8
2003 184.0 85.766 2.3 107.8 86.869 2.1 94.100 85.846 2.1
2002 179.9 83.855 1.6 105.6 84.920 1.2 92.118 84.038 1.6
2001 177.1 82.550 2.8 104.3 83.874 2.3 90.650 82.699 2.3
2000 172.2 80.266   102.0 82.025 88.647 80.871  
Sources

Bureau of Labor Statistics, U.S. Department of Labor (http://www.bls.gov/cpi/data.htm), All Urban Consumers and All Urban Consumers (Chained CPI)
Bureau of Economic Analysis, U.S. Department of Commerce (http://www.bea.gov/national/nipaweb/SelectTable.asp), Table 1.1.9. Implicit Price Deflators for Gross Domestic Product

The Chain-Weighted All-Item CPI differs from the standard All-Item CPI in that the weights assigned to goods in the index change over time. The percentage figures reveal that the chain-weighted index yields slightly lower inflation rates than the standard CPI in the period 2000-2009. The GDP Implicit Deflator, also a common inflation measure, yields an inflation rate similar to those of the two CPI indices but not consistently higher or lower than either of them.

What About Discounting?

If you are comparing two interventions, each involving a series of expenditures over time, you need to consider the time value of money (the fact that a dollar spent today is a bigger expense than a dollar spent a year from now). This requires application of a discount rate. The Public Health Service Panel on Cost-Effectiveness in Medicine recommends a discount rate of 3% (Lipscomb et al., 1996). To find the incremental cost-effectiveness ratio, the discount rate should be applied to both real costs and to outcomes measured as quality-adjusted life years.

Discounting should not be confused with adjusting for inflation. Both are needed. The inflation adjustment reflects the change in purchasing power of currency. Discounting reflects the loss in value when there is a delay in obtaining an item of value. We discount expenses and health outcomes if there is a delay in realizing them.

References

Berndt ER, DM Cutler, RG Frank. JP Newhouse, JE Triplett. Medical care prices and output. In Handbook of Health Economics, Volume 1, AJ Culyer and JP Newhouse, eds. San Francisco: Elsevier, 2000.

Bureau of Economic Analysis, U.S. Department of Commerce. Gross Domestic Product (GDP). http://www.bea.gov/national/index.htm#gdp (accessed Dec. 2, 2010).

Bureau of Labor Statistics, U.S. Department of Labor. Consumer Price Index. http://www.bls.gov/cpi (accessed Dec. 2, 2010).

Lipscomb J, Weinstein MC, Torrance GW. Time preference. In Cost-Effectiveness in Health and Medicine, M Gold, J Siegel, LB Russell, and MC Weinstein, eds. New York: Oxford, 1996.