The Inflation Question

The inflation rate describes your purchasing power. As we’ve watched the markets struggle to stay afloat, purchasing power, the cost of living, and the role of inflation in all of this becomes more important. And by now, we’ve all certainly noticed that the price of goods and services is rising, and that money doesn’t go quite as far as it used to.

The inflation rate is measured using the Consumer Price Index. This index represents average changes in the prices paid by urban consumers over time for a specific group of goods and services, including food, clothing, shelter, medicine, and health care. The U.S. Bureau of Labor Statistics collects and analyzes the data, publishing a monthly statement on the Consumer Price Index and inflation. The Federal Reserve tries to maintain inflation at about 2 percent to 3 percent each year. As of September 30, inflation stood at 5.36 percent.

The effect that inflation has on a person depends on individual circumstances. Skyrocketing gasoline prices, for instance, have a profound effect on a single mother driving a 10-year-old gas guzzler to her factory job that is 25 miles from home. Those same increases wouldn’t be nearly as costly to the urbanite professional who rides a Vespa to work.

Tough on Retirees

Retirees living on a fixed income, may see their buying power dwindle as inflation eats into their investment returns. As a result, their standard of living could decline.

For instance, let’s say you purchase a $10,000 Treasury bill with a 10 percent annual interest rate and hold it for one year. At the end of that year, you receive $11,000. But if inflation increased by 3 percent that year, the earnings on that T-bill would really be 10 percent minus 3 percent—so 7 percent, or $700.

Studies show that seniors spend less money on new cars, gas, clothing, alcohol, and tobacco products, but spend more on travel and recreation than younger people. So retirees see inflation affecting their travels more than their everyday purchases. They feel the pain of a weak dollar much more when they pack their bags and head off to Europe or the U.K.

At the dollar’s lowest point in late April, it cost more than $1.60 to buy one euro—meaning that the $10 pasta dinner in Florence, Italy, cost $16. It took $2 dollars to buy one British pound earlier this year. Compare that to 2006, when it cost $1.84 to buy one British pound.

If you think that’s bad, consider the impact inflation has on retirees who maintain an overseas residence. While it may be difficult to muster a great deal of sympathy for those folks, what used to be a relative bargain when the U.S. dollar was strong has turned into a much more expensive proposition during the last several years.