What Is Base Effect?

Base effect is often a term used in relation to economic indicators such as inflation and IIP data which are primarily based on the base effect of last year. To better understand this best effect it will be best to explain it using an illustration-

What Is Base Effect?

Say to report an increase in the general price level of commodities or the rate of inflation price index is referred to say for instance if the price index for a given year taken as base was 100 and now after a year it has inched higher to 110, the rate of inflation is now 10%. And after a year, if it has inched to 120, the effect shall be less prominent in the second case with the lower rate of inflation.

The said effect is felt as the higher impact that is the rate of inflation of 10% which is though high at the first instance made the price increase effect felt less in the second case even though the actual increase is of 10% but on relative terms the effect shall be different and this distortion is what is referred as the base effect.

Importantly, to be noted at the first case, the base price index to arrive at the rate of inflation is 100 while in the second case it is 110 and this is what causes all the difference even with similar change on the actual basis.

So more precisely we can say that abnormal levels of an economic indicator at the first instance, makes the assessment of the same in the immediate month difficult with no proper course to arrive at the exact conclusion for it. This hence causes disruption.
The base effect no longer remains eminent in a case when the economic indicator under consideration remains constant on a relative basis over time.

Higher IIP number for December partly attributed to base effect

IIP data for the month of December painted a promising picture with manufacturing signaling revival post demonetisation and GST. And experts have partly owed this increase in IIP data partly to the base effect which simply means that as the data in the corresponding period did not hold a good picture, the effect felt or the IIP index number arrived at looks promising in comparison.

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