DEFINITION of 'Base Effect'
The consequence of abnormally high or low levels of inflation in a previous month distorting headline inflation numbers for the most recent month. A base effect can make it difficult to accurately assess inflation levels over time. It wears off over time if inflation levels are relatively constant.
BREAKING DOWN 'Base Effect'
Inflation is calculated from a base year in which a price index is assigned the number 100. For example, if the price index in 2010 was 100 and the price index in 2011 rose to 110, the inflation rate would be 10%. If the price index rose to 115 in 2012, what would be the best way to assess inflation? On the one hand, prices have only risen 5% over the previous year, but they've risen 15% since 2010. The high inflation rate in 2011 makes the inflation rate in 2012 look relatively small and doesn't really provide an accurate picture of the level of price increases consumers are experiencing. This distortion is the base effect.