2010-09-15

Inflation into perspective

Most people know enough about inflation to recognize the effect that goods and services increase in price over time. Typically the change in the consumer price index (CPI) is used to represent current inflation in the United States. For a moment in this article let us assume that the methods for computing the CPI are accurate and reasonable.

Some employers attempt to compensate for inflation by adjusting salaries, by giving inflationary raises at the end of the year, however many employers do not. Many people currently concerned with the economy have taken investments and placed them into a stagnant bank account earning fractions of a percent in interest. Let look at an example for those who have stagnant savings (let us assume they have saved one year worth of their salary) and for those folks who do not get an inflationary raise every year.

Leaving out job benefits, assuming 52 weeks a year, 3 weeks paid time off, and 5 day work weeks... each day of work equates to approximately 0.4% of a year's salary. If inflation goes up 1% a person will have essentially need to work 2-1/2 extra days of time in order to equate the previous year's value. The person with savings will essentially have lost 2-1/2 days worth of pay. 2% increase is approximately one work week (5 days) of value lost. 5% is almost 2-1/2 weeks.

Some alternative inflation charts show us currently at 8.5% inflation (4 weeks of work). Now multiply this over a period of a few years... those who have one year worth of salary (or more) in stagnant savings for more than 3 years, have essentially lost 1/3 of their purchasing power. To carry the illustration further, some projections suggest that the United States is headed for 20% inflation (2-1/2 months of work.)

The reality is not this simplified. Various products are affected in different ways (and at different times) by inflation. I post this exercise to help people realize that while the $dollar$ amount may not be changing from year to year... the value is.

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