This article was originally published on ETFTrends.com.
By Dr. Sonu Varghese via Iris.xyz
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Inflation is a bad thing, right? It make things more expensive, right? For those of us of, let’s say, a certain vintage, we recall the runaway inflation of the late 1970’s and early 1980’s. So why does the Federal Reserve – in charge of managing the country’s currency and value thereof – actually try to create inflation? It’s called the inflation targeting and it matters to your money.
What is inflation?
Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. The key phrase here is “goods and services” which translates into “the things I buy”. Spoiler alert: not all of the “things I buy” have the same rate of inflation.
When the price level rises (i.e. when inflation is present), each unit of currency - in our case the US Dollar - buys fewer goods and services. Stated another way, the same amount of goods and services (the things I buy) costs more units of currency (i.e., dollars, but feel free to use “units of currency” at your next dinner party, it will make you sound really smart but nobody will want to talk to you for the rest of the night). But if my salary from my job or income from my business is growing at the same time, who cares if the things I buy cost more?
It’s nominally very real
Two key concepts that you must know when thinking about inflation its effects are “nominal” and “real”. “Real” values (the cost of producing a widget or your monthly salary for example) have been adjusted for inflation while “nominal” values have not. So, if your annual income increased by 5% in a given year (nominal) and the inflation rate for that same year was 5%, how much real income increase did you experience? Choose from A) Bupkis, B) Nada, C) Zero and D) All of the above.
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