Monday, February 20, 2012
What Is Inflation?
That is a good question and one that unfortunately there has not been an answer that everyone agrees upon. The term is a general description of the decreasing value of a unit of money over time. Therefore if you were to have 5 dollars now and went out and buried it and left it there for fifty years you would not have as much purchasing power with that 5 dollars that you had back when you buried it.
This is what scares lots of people into investing. You see in order to beat inflation and actually have something of their retirement savings when they need it most they will have to beat the rate of inflation with their money. One of the only ways to do this is to is to invest at a rate that beats the rate of inflation. This is often more than the rate that a typical savings account will get you even when you take into account the concept of compounding interest.
So what determines inflation? It can either be described as the increasing prices for goods or services as measured by the consumer price index. Or it can be viewed in terms of the overall increase in the supply of money. This is often created by the government printing more money in order to meet the demands of a larger and larger (more global) demand for US dollars (for example). The government prints and ships this out to the world in order to better meet the demand and stop prices from falling.
Who else, other than the government, has the power to change the rate of inflation? Well who else would it be other than the federal reserve. The federal reserve is a consortium of some of the top banks in our country who serve as a committee that decides where to set interest rates in order to enhance the economy and prevent recession. Lowering interest rates tends to promote buying and selling of goods and services on credit or loan. Increasing the interest rates on the other hand promotes the savings of dollars in the bank and is a sign of a stronger economy when this all happens.
So what is the moral of the story? Well invest to beat the effects of inflation for one thing. And secondly don’t get bent out of shape by the increasing prices that are just a fact of life. No one can explain them and eventually they will probably be reset lower and that will be like the “fall back” of daylight savings terminology.