Base effect

The Base effect relates to inflation in the corresponding period of the previous year, if the inflation rate was too low in the corresponding period of the previous year, even a smaller rise in the Price Index will arithmetically give a high rate of inflation now. On the other hand, if the price index had risen at a high rate in the corresponding period of the previous year and recorded high inflation rate, a similar absolute increase in the Price index now will show a lower inflation rate now.

An illustration of the base effect would be like: Price Index 100 goes to 150, and then to 200. The initial increase of 50, gives the percentage increase as 50% but the subsequent increase of 50 gives the percentage increase as 33.33%. This happens arithmetically as the base on which the percentage is calculated has increased from 100 to 150.