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Why Inflation Is Good For You

Posted By Jim On 08/04/2010 @ 12:18 pm In Personal Finance | 19 Comments

Inflation is the invisible erosion of our money’s purchasing power. It doesn’t sound like it’s good for you, right? Economists have said for quite some time now that inflation is good for you, it’s good for the economy, and part of a healthy market. Yet when things are more expensive, I feel like it’s a bad thing and you probably do to.

This post won’t be about the esoteric economic benefits of inflation, you can read that in a textbook. This will be an explanation of the real and tangible effects of inflation on you, regular Joe or Jane Doe and your family.

Debt Is Cheaper

When the purchasing power of the dollar decreases with inflation, so does the weight of your debt. The total dollar amount of your debt won’t change, minus your payments, but the weight of that debt on your household budget will diminish over time. This is why many people say that a home mortgage is a hedge against inflation.

If you opened a 30-year fixed $100,000 home mortgage at 5% ten years ago, ten years of payments will have lowered the balance to $81,342.28. We can use BLS data and their inflation calculator [3] to calculate the purchasing power of $81,342.28. $81,342.28 in 2000 has the same purchasing power as $102,981.12 today (2010). If you had a $50,000 salary in 2000 and were given raises pegged to inflation, you’d be making $63,301.10 today. Your mortgage payment wouldn’t change, that’s set for the life of the mortgage, but everything else has inflated around it.

So why do people advocate paying down debt? It’s because of the interest payments. Inflation has a powerful impact when you’re talking about mortgage rates for two reasons – the interest rate is fixed and the mortgage interest rate is low relative to the inflation rate. When you start talking about double digit credit card interest rate, inflation looks tiny next to such large numbers.

Companies Can Increase Prices

This is a bit of a chicken & egg type of reason but it’s still a valid one. When there is an economic recovery, companies will see an increase in demand and can start raising prices, prices they likely dropped or held low because of decreased demand. Consumers may not like seeing higher prices but it’s a sign that a company is growing stronger and it gives them the confidence to hire more workers.

More workers means increased productivity and fewer people on unemployment. It means there are more people with more money to buy goods and the cycle feeds into itself. It also means that salaries will likely go up as demand increases. A higher salary is good, right?

So while prices might be going up, which seems like a bad thing, it’s going up for a good reason. It’s like buying new clothes because you’ve lost weight.

Forces People to Spend

This sad story about North Korea [4] shows how changes in the value of currency can force people do seemingly erratic things. When North Korea devalued it’s currency (and capped conversions), people started paying “exorbitant” prices for some products.

Why is forcing investment and spending good for you? It strengthens the economy as a whole even if it, seemingly, weakens you individually. If you have a lot of savings and you are surrounded by people who are unemployed, are you better off? You might be individually but your neighborhood falls into disrepair as your neighbors can’t afford to maintain their homes.

In the end, inflation is a good thing even if you aren’t an economist. We can all agree that when our society grows and prospers, it’s more likely that we will individually prosper even if it’s not as obvious when we are forced to pay more for the same products.

Can you think of any other good reasons why we should embrace and encourage some inflation?

(Photo: vegaseddie [5])

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[2] Email: mailto:?subject=http://www.bargaineering.com/articles/why-inflation-is-good-for-you.html

[3] inflation calculator: http://data.bls.gov/cgi-bin/cpicalc.pl

[4] sad story about North Korea: http://www.nytimes.com/2010/06/10/world/asia/10koreans.html?_r=1

[5] vegaseddie: http://www.flickr.com/photos/vegaseddie/4353407858/sizes/m/

Thank you for reading!