What does indexing involve?

Indexing involves adjusting a nominal quantity to reflect changes in inflation, ensuring that the purchasing power remains constant over time. This process is essential in various economic contexts, such as wages, pensions, or other financial contracts, where maintaining the real value against inflation is critical. By increasing nominal amounts based on an index, typically the Consumer Price Index (CPI) or a similar measure, individuals and entities can protect themselves from the eroding effects of inflation.

For instance, if wages are indexed to inflation, employees' salary adjustments would ensure that their earnings do not lose value as overall prices rise, helping maintain their standard of living. This practice is particularly relevant in long-term contracts where inflation over time could significantly affect the value of payments. Thus, indexing serves as a crucial mechanism for economic stability and fairness in financial agreements over time.