What Is Indexation?

Indexation is a system or technique used by organizations or governments to connect prices and asset values. It’s accomplished by l🐈inking adjustments made to the value of a good, the price of a service, or another specified value to a predetermined price or composite index.

Indexation requires identifying a price index and determining whether linking the value to the price index will accomplish the organization’s goals. It’s most commonly used with wages in a high-inflation environment. Indexation is also known as 澳洲幸运5开奖号码历史查询:escalating.

Understanding Indexation

Indexing a given price or payment to other prices can 𝄹serve two main purposes. It’s a pre-specified process. All parties involved are typically aware of how t♓he link works.

Two or More Goods or Services

Indexation can be used to maintain a stable relative price between two or more goods or services. This iꦇs done by specifying the desired target ratio of two prices and adjusting one pric🔴e when the other changes to maintain the ratio.

An ice cream stand might index the sale price of ice cream cones to the wholesale price they pay for ice cream. This maintains a steady 澳洲幸运5开奖号码历史查询:profit margin by keeping the price of the cones constant relative to the cꦅost of bulk ice cream. The output price and the business remain profitable if the whol🌸esale price of the input doubles.

Purchasing Power of a Currency

Indexation can also maintain ꦉa stable real price of a good or service relative to 🅰the purchasing power of a currency unit.

A price or asset value is linked to the price level of a basket of good💛s, which is usually set equal to 100. Price indexes are commonly published by official government agencies, often for the specific purpose of convenient use in the indexation of prices,🐻 wages, and transfer payments. 

Businesses may use this type of indexation to match an employee’s salary increases to the inflation rate. An increase in the consumer price level over time will lead to an increase in salary. This particular type of indexation is called a 澳洲幸运5开奖号码历史查询:cost-of-living adjustment (COLA). 

Why Indexation Is Necessary

The use of indexation can theoretically mitigate the impact of inflation on a worker’s 澳洲幸运5开奖号码历史查询:standard of living. Most workers would effectively be getting a real wage cut each year as inflation cuts into the 澳洲幸运5开奖号码历史查询:purchasing power of their nominal wages. But there are still possibilities for economic changes to force some disparit🅺y between salaries and the pace of inflation.

Governments might similarly use indexation as a way to potentially alleviate the negative effects that inflation can have on t🐬he recipients of transfer payments and entitlements.

Types of Indexation

Prices and wages can be indexed o𒅌ver different geographic areas. A company with employees in multiple states or cities might want to link compensation in other areas to local prices because rents and costs of living vary from place to place. This can be accomplished by indexing pay to the prevailing wages paid by other businesses in those areas or by using an index such as🧸 the Regional Price Parities published by the Bureau of Economic Analysis.

Various assets and values might be subject to indexation. Some countries might apply indexation on certain types of tax payments at varying periods. It can be applied to debt mutual funds that have been held for a certain minimum amount of time before being sold. The original purchase price is adjusted for inflation when calculatin🐬g long-term capital gains that will be taxed when those debt funds are sold. This can lead to a discount on taxes for the seller after the tran🗹saction.

Indexation might also be applied to pension funds to reassure parti🍸cipants that their assets will keep pace with inflation. The value of those assets won’t 🐼erode as time passes.

Life insurance companies might offer their clients policies that include terms for indexation. They might promise a payout that’s adjusted for inflation. The premiums for such plans can be higher with annual increases, however. Such a product might raise concerns about consumers overspending on premiums, especially during periods when inflation is minimal and below the rate of increase that’s charged for indexation.

The Bottom Line

The term “indexation” essentially translates to “adjustment” in terms of the values of ♈goods and services commonly purchased by businesses and consumers. Adjustments are based on changes in various price data and ideally keep pace with the effects of inflation over time. This can mean taking actions such as increasing the minimum wage when the costs of groceries are climbing.