Re: Average Inflation Question


1_Patriotic_Guy wrote:
If I know inflation between year one and year two, and between year two
and year three, and so on -- How do I calculate the average inflation
over a multi-year period -- There has to be a formula which involves
plugging in the annual inflation rate for each and every
year. Below is my best guess at an answer, but how do I
handle input negative inflation years (e.g. just inputting a negative
number doesn't seem like the right approach, doesn't seem to properly
influence the average.)
Convert each inflation rate to a factor, so 3.5% becomes 1.035,
2.3% becomes 1.023, and so on. Multiply all N factors together and

then take the Nth root of the product. Then convert the factor so

obtained back to a percentage in the obvious way.

That is an excellent best guess. Yes, the correct approach is to use
the geometric mean (http://en.wikipedia.org/wiki/Geometric_mean).

"The geometric mean is useful to determine 'average factors'. For
example, if a stock rose 10% in the first year, 20% in the second year
and fell 15% in the third year, then we compute the geometric mean of
the factors 1.10, 1.20 and 0.85 as (1.10 × 1.20 × 0.85)^1/3 =
1.0391-1... and we conclude that the stock rose 3.91 percent per year,
on average." -Wikipedia

.

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