A Discussion Regarding Inflation
Money Today or Money Tomorrow?
In the illustration of corn flakes and gasoline, it's clear that inflation changes the value of a dollar over time. Given that, consider our first life question.
|Would you rather receive $1,000 today or $1,000 ten years from now?|
Did you say you'd rather receive $1,000 today? If so, that would be a good financial decision! Suppose you earned and spent $1,000 last year. Suppose also that inflation caused prices to rise an average of 3%. If the cost of the items you typically buy increases by the inflation rate, what you bought last year for $1,000 will cost $1,030 this year—3% more.
What does this mean for you? In short, to buy the same amount of goods and services this year, you'll need a raise, and if you don't get one, you won't be able to buy as much. The $1,000 last year was worth more—bought you more goods and services—than $1,000 this year.
Chances are, in 2015, $50 won't buy as
many groceries as it does in 2010.
(For illustrative purposes only; not a representation
of actual current or future values.)
As shown by the grocery bags above, each year, the same amount of money will get you less and less. Given that, it seems rather clear that money today is better than money tomorrow, but do you understand why? Consider the following question.
Inflation's Relationship to Opportunity Cost and Interest
This applies to money saved or loaned. If you save or lend $1,000, that $1,000 likely won't buy as much by the time you take it out of savings or receive the repayment on the loan. Therefore, if people are going to save/lend money and accept the risk of inflation (or even default!), they must be compensated with interest. The purpose of interest payments on savings or on loans is to cover losses in purchasing power due to inflation and to reward the saver or lender for forgoing current spending. Interest also rewards the lender for taking a chance on lending money that might not be returned.