2.2 The development of the cost-of-living index

The value of money plummeted in Europe in the wake of the First World War. This prompted growing interest in the theory of inflation and in monitoring inflation. Throughout Europe, almost every country began to compile and compute its own cost-of-living index.

Inflation means that prices go up and the value of money decreases: the same amount of money buys you less goods and services than before. Deflation means that prices go down and the value of money increases: the same amount of money buys you more goods and services than before.

The purpose of the cost-of-living index was to measure the development of the prices of goods and services purchased by households. Work to compute the index was started soon after the war, with the base period set at a time-point before the war. In Finland, the first cost-of-living index was compiled in 1921, and the base period was set at January-June 1914 (1914:1-6=100). The index's consumption structure was based on the first ever household consumption survey in Finland in 1908-1909, where urban households were asked about their spending on food, clothes, housing etc. Since then, cost-of-living time series have been retrospectively built back to 1860. Like almost all other countries, Finland decided to calculate its indices using the formula developed by German economist Etienne Laspeyres. We will be looking at different index formulae in closer detail later on under topic 3.4. Different index formula.