How Does Inflation Affect the Value of Money?
Inflation is largely defined by a rise in the cost of goods and services. That increase occurs when consumers, businesses and the government demand more goods and services than the economy can provide. The greater demand allows manufacturers and service providers to raise their prices.
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Effects
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The value of money decreases with inflation as the prices for goods and services rise. Therefore, the purchasing power of consumers declines as their salaries remain unchanged and the cost of living grows.
Savings Accounts
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Savings accounts also can be adversely affected by inflation. If the interest earned on a savings account does not offset risings costs, then the true value of the money in the account is diminished.
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Interest Rates
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Low interest rates on loans also can spur inflation. As interest rates drop, the money supply is effectively increased because more people are willing to take out loans. They ultimately increase their spending with loans they receive, driving up the demand for goods and services. Yet the low interest rates make money worth less.
Consumer Price Index
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The Consumer Price Index is the main measure of inflation. The CPI lists goods and services that consumers buy. Economists can calculate inflation rates through year-to-year comparisons of prices for goods and services included in the CPI.
Expert Insight
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Most of the CPI represents the spending patterns of consumers in urban metropolitan areas. According to the Bureau of Labor Statistics, that includes about 87 percent of the U.S. population. The CPI is intended to represent purchases made by professionals, the unemployed, retirees and others.
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