Oh, Grandma. You say I’m so rich with my salary. But you haven’t left your house in forty years and don’t do your own shopping. Milk used to be a nickel; now it’s three dollars. A burger used to be a dime; now they’re six dollars. Plus you didn’t even have student loans to pay, and you owned a house at my age. I’m not rich. Inflation, Grammy. Inflation!
Price inflation is when the prices of goods and services rise, often expressed as baskets of goods per year. The Consumer Price Index has lots of baskets, like education, transportation, food—all the stuff most people buy regularly. It’s “inflation,” because incomes rise, too. When prices and income both rise together at the same rate, then buying-power stays relatively the same. This is what Grandma doesn’t understand. Tell her inflation is so important that the Federal Reserve uses it to set monetary policy. If inflation is too high, that’s dangerous...so banks will increase interest rates. If it’s low, then the Fed can lower interest rates. See, Grandma...see? Price inflation is real.
So what’s the point of inflation if everything stays the same-ish? Your income goes up, but if prices go up, then you’re back where you started anyway.
There are only theories to explain inflation, but one is that, as there’s more money pumped into the economic system from growth, it creates more dollars to buy more things. Which means there’s a higher supply of money than goods demanded, making prices rise, and incomes in turn.
Related or Semi-related Video
Econ: What are Real Interest Rates and I...0 Views
And finance Allah shmoop what are really interest rates and
inflation Correction Riel interest rate of percent figure that tracks
her actual interest in any given conversation like you bump
into your old roommate and he starts talking about his
foot polyp riel Interest rate Fifteen percent He starts talking
about the time he was kidnapped by Basque nationalists while
on a yacht with Kate Upton Riel Interest rates yet
ninety five percent Well the more famous version of a
really interest rates have to do with finance It tracks
the rate of interest after subtracting the impact of inflation
Right So it's real It's not just nominal Your friend
wants to buy a pure bred show pig for next
year's County Fair It costs a grand but she doesn't
have the cash on hand so she borrows the money
from you You agreed alone the thousand dollars for one
year at fifteen percent annual interest That's the interest rate
written into the contract The nominal rate The loan has
to be paid back at the end of the year
Well meanwhile the inflation rate this year totals five percent
Prices on everything They're going up up up by an
average of five percent during those twelve months when the
money was borrowed So you alone the grand on January
one and buy the next December thirty one while you
get eleven fifty back That's fifteen percent nominal interest However
inflation has eaten into some of that profit for you
At least rent on your money every January you like
to buy a set of dinosaur shaped novelty T infuser
Sze to give away his New Year's gifts last January
you could buy a hundred tea infusions for thousand dollars
this New year's those same hundred T infuser is cost
a thousand fifty right The five percent inflation is at
work when you loaned the money out Well eleven hundred
fifty dollars could buy you one hundred fifteen t infuser
by the time you get the money back While eleven
fifty will only buy you about one hundred ten tion
fuse er's and you'll have to throw in about five
dollars of extra money to get the one hundred tenth
one of the math They're well Your money buys last
because of inflation The real interest rate takes into account
what you can buy with the money Write it subtracts
inflation from your rate of return So here is the
back of the envelope Way to calculate the rial interest
rate Take the nominal rate and subtract the rate of
inflation Yep that's it Bingo What's left over is the
real rate Very fancy The answer you get when you
do this calculation is approximate but it's an easy way
to get close See alone out the thousand dollars of
fifteen percent interest but inflation that years five percent So
fifteen minus five is ten in the rial interest rate
here Yes it's ten percent Well that checks out if
you don't count money as money but counted as what
you can buy with the money like T infuse er's
Last January one you loaned out enough money to buy
one hundred T infuser a thousand dollars back one An
infuser cost ten bucks each Now it's December thirty one
In the same year you got back enough money to
buy approximately one hundred ten T infuser Right You got
eleven fifty back but infuser is cost ten fifty each
Now Right five percent inflation One hundred fuses worth of
money last year turned into enough to buy one hundred
ten in futures this year one hundred to one hundred
ten That's ah ten percent net riel return That's the
rial interest rate When you're the lender inflation eats into
your profit What should be a fifteen percent return then
becomes a realty ten percent return because five percent of
our money got slurped up by higher prices On the
other hand well it can be helpful in the same
deal your friend is paying you back in currency That's
five percent easier to get arm or liquid When you're
a borrower inflation helps you pay off alone easier It's
why a lot of countries who are highly in debt
love having inflation because it makes their debt so much
easier to pay back That's why lenders have to keep
the inflation rate in mind when they're quoting raids for
what they'll lend money at So let's look at it
on a national scale Greece is in trouble yet again
The country needs like eighteen billion dollars in loans from
the World Bank just so it can afford the marbled
cleaning bill for the Parthenon The World Bank has to
decide what interest rate to charge Well inflation's been running
high lately Last year was eight percent Experts predict it
will be about that same level for the foreseeable Yes
we're totally making up these numbers with the real world
way lower than that Meanwhile the World Bank wants to
secure a really interest rate of five percent Well what
does it do Well it wants a five percent real
rate when inflation's aid so it has to set the
nominal rate that's going to charge Greece to about thirteen
percent That's by plus eight equals thirteen even in Greece
So what about inflation Correction Well inflation correction is the
process of taking inflation out of an equation You adjust
a figure to take inflation into account It's the process
you're using to determine the rial rate Will the nominal
rates thirteen percent inflations eight percent after correcting or adjusting
for inflation while you end up with a real rate
Then of yes five percent Grease takes its loan with
thirteen percent interest Now it can keep the Parthenon sparkling
clean and tracked all those tourists who keep it out
of bankruptcy And hopefully it'll bring in enough dough to
fix the Olympic Stadium next year Good luck with that 00:04:52.71 --> [endTime] grease
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