What is Inflation Exactly?
April 7, 2010 by Pete Mitchell
Filed under All Posts, Other Market Info
What is Inflation Exactly?
I get this question a lot. What exactly is inflation? Inflation, to kind of make it really simple, is when the value of everything goes up except for the cash in your pocket, which stays the same.
So an easy way to understand this is let’s say a loaf of bread cost $1 this year. Now, I know a loaf of bread doesn’t cost a dollar, but we’re going to use that as the example. And next year, let’s say inflation over the course of the year is about 2%. Next year that means that loaf of bread is going to cost you $1.02. However, if you made $1 this year, next year you’ve got to make that extra 2¢ so another 2%, so you can still be at break-even.
Now how we gauge inflation in the United States is through something called the consumer price index, and there’s a lot of debates as to whether or not our consumer price index is actually a good model to be using because of some of the things that are in it. But the bottom line is, it is a good way for use to address this problem of inflation, because it is a problem.
As we look at it historically, and consumer price index, the rate of inflation has been traditionally between 2.5% and 4.5%. And of course there are years where it spikes, like with the Carter administration we saw inflation off of the charts. And there’s also years like in 2009 when inflation did 0%, and that was one of the things that really messed up a lot of seniors because they’re used to getting that cost of living increase in their Social Security checks and they didn’t get it for this last year. So what we use to gauge inflation is that consumer price index.
It is something good that you can use as kind of like a guide, but just bear in mind that you’re going to have to plan for inflation in all of your retirement planning. And inflation’s going to run between 2.5 and 4.5%, so a good, safe bet is to plan for about a 3.5% inflation. So I hope that helps.
Pete Mitchell here. I look forward to sharing more on the markets and investments with you tomorrow.
