WHY IS INFLATION BAD
We are conditioned to accept inflation as normal – as long as it doesn’t get out of hand! But is it healthy to accept inflation as a given fixture of our economy? No. For psychological reasons the Federal Reserve targets an acceptable inflation rate of 2% but actually runs upward of 3%.
If you think of inflation in terms of milk, a 2-3% increase in prices from year to year is not going to cause any great heartburn – a 6 cent increase year over year. No one is going to blink an eye. The numbers get bigger if you consider the cost of operating a car – 2% inflation is going to cost you an extra $200-300 a year. But it’s still insignificant for most people – until you look at it differently.
Suppose you have worked your entire life and amassed a net worth of $500k. The value of that savings is how much it can sustain life in the future. At 3% inflation, the effective buying power of your savings drops by $15000. As with anything in life, inflation will affect different groups of people differently at different times of their life. Savers are hurt by inflation. Low wage earners are hurt by inflation. Retiree’s are hurt by inflation. In fact, technically everyone is hurt by inflation, it’s just a question of how bad it hurts. Some feel it worse than others.
Inflation hurts worse over time. I like to look at inflation through the lens of net worth because the numbers are not able to hide behind the obscurity of $0.06 annual increase in milk. So if you consider a networth of $500k, then purchasing power goes from $500,000 down by $75,000 in 5 years. Down by $150,000 in 10 years and down $300,000 in 20 years.