Wednesday, 23 June 2010

Inflation Killed My Pocket Money

Here Sonny boy take this 10p and go buy yourself a handful of sweets" ... yes Grandma i think you will find you can no long buy a humble Fredo with that!

Inflation is often a concept none economists easily over look. People will look at the public sector (for example) and ask why are they complaining about a 1% pay increase? Its an increase isn't it? No it is not, if inflation is higher than 2%. If inflation is 2% that means everything will cost 2% more than last year so their wages from last year will be able to buy less. While this is not a fall in nominal income it is a fall in real income. This means that a 1% wage rise is actually a pay cut in real terms.
(This means that the pay freezes, which means no more pay increase, in the public sector as stated in the budget is actually a cut in real terms.)
Value can also confuse some people, consumers can easily be thrown off track by inflation as the hypothetical granny was. To assume that something will cost the same as it did ten years ago is folly because firms will have raised their prices due to inflation. If your pocket money as a child (if your lucky enough to get any) never saw an increase then it means it will have fallen in value significantly over time. "Your lucky back in my day we got 50p a week" is a failure of a statement.. back in your day 50p could buy a lot more!
On a final note, if you can grasp this concept you will be able to understand that over time the value of your savings fall. If interest rates are less than inflation then in real turns saves are devaluing... using this theory we can move into Micro Economics because this is one of the main principals of Monetary policy......

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