Adjustment Index Defintition

What Is an Adjustment Index?

The term adjustment index refers to a modification that is applied to a data set in order to make it a better representation of external conditions. Without the use of an adjustment index, the data in question may be distorted. An adjustment index can be a formula-based modification or a single number derived from an external set of observations. It is often used when reporting economic indicators such as seasonal employment.

How Adjustment Indexes Work

Almost everyone relies on financial and economic data in order to make important decisions. Investors need this information to make informed decisions about their investments. Corporations and governments depend on it to help their businesses grow and to ensure the economy flourishes. That's why it's so important that the information provided is accurate. This is where the adjustment index comes in handy.

Adjustment index is a term that has applications in a wide range of contexts. On its own, it refers to a numerical alteration of specific data to improve the accuracy or utility of a dataset. Improvements may try to remove distortions such as seasonal ebbs and flows in a particular data set or to account for a relatively small sample size.

But that's not all. Other applications of the adjustment index may be used to update an out-of-date piece of data to better represent present-day conditions. It can also improve the comparability of distinct data sets. Ultimately, an adjustment index can provide context for a stand-alone data set and thus maximize the applicability of that information. Indices do this in a huge variety of situations.

In business transactions, parties can use an adjustment index to allow for modifications based on prevailing market conditions. Governments and economists can alter data to account for seasonal flows in spending and employment in order to get a better representation of economic conditions. For instance, U.S. economists make regular adjustments to the country's jobs numbers to account for additional hiring during the Christmas season. Without modifications, the unemployment rate would be skewed and artificially inflated, as more people end up back in the workforce for these temporary jobs for the duration of the season.

Economic data such as the jobs report is often adjusted for seasonal factors to avoid it from being artificially inflated.

Examples of an Adjustment Index

Adjustable-Rate Mortgages (ARMs)

Perhaps the most widely known adjustment index is the one that lenders use to reset adjustable-rate mortgages after the initial period has expired. This typically takes place anywhere between three to 10 years into the life of an ARM. At that point, the lender uses an adjustment index to reconcile the loan’s initial rate with prevailing market rates. The rate most frequently used is the London Interbank Offered Rate (LIBOR). The lender takes that index and adds a margin to set a new interest rate for the loan.

Human Development Index (HDI)

A second example demonstrates how researchers can use an adjustment index to compare a variety of data sets. The United Nations Development Program (UNDP) maintains a Human Development Index to track countries’ achievements in health, education, and income.

The HDI of various countries can be compared to demonstrate those countries’ relative levels of progress on those measures. However, this index consists of aggregate measures of development for each country and did not originally contain information as to how equally the benefits of development are distributed within each country.

Based on the assumption that inequality necessarily degrades a country’s true level of human development the UNDP decided that this information was relevant to the measure of HDI. To address this issue, the UNDP developed an inequality index in 2010. It applied this index to the HDI to create an inequality-adjusted HDI. This adjustment index allowed the UNDP each year to adjust the index in a way that boosts the index of human development in countries with greater equality.

Consumer Price Index (CPI)

Another adjustment clause allows parties to a business or personal contract to modify that agreement according to external economic variables. The Consumer Price Index (CPI), published monthly by the Bureau of Labor Statistics (BLS), is a commonly used adjustment index that parties to a contract will use to structure an escalation clause. This is common in a wide variety of agreements ranging from labor union wage scales to commercial leases to alimony payments. As the CPI rises or falls, the payer’s financial obligation also rises and falls.