I used this calculator: http://www.buyupside.com/calculators/inflationjan08.htm to estimate the future worth of 100 dollars in 100 years at 2% inflation. Does this really mean that a decent meal at a restaurant will cost about a $100 in the future or am I misunderstanding something? So basically what I'm asking is if at some point in the future will McDonald's Dollar menu become the Hundred Dollar menu?
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2$\begingroup$ This question, I think, is off topic because it is about elementary arithmetic, not about economics. $\endgroup$– Steven LandsburgCommented Dec 30, 2014 at 15:35
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5$\begingroup$ I think it's more about the economic implications. He's done the elementary arithmetic, that part wasn't a problem - the problem seems to be, he can't quite believe or make sense of what he understands the real world economic implications of the results to be, and is looking for clarification. $\endgroup$– user56reinstatemonica8Commented Dec 30, 2014 at 15:43
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5 Answers
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"Worth less" than before - yes, that's exactly what inflation does.
"Worthless" - not quite. No percentage-based reduction in value can make something worth 0, but there are extreme examples from history of times inflation has spiralled so far out of control ("hyperinflation"), money became worth less than the paper it was printed on, and life savings became almost worthless.
1920s Germany is the most famous example, but there are more recent examples, such as Zimbabwe.
This is a real Zimbabwean banknote from 2009 - you don't need the terrifying inflation rates to see that savings of thousands of Zimbabwean dollars made in the early 2000s had become effectively worthless:
But those are extreme examples.
As for the idea of a McDonald's $100 Menu - it wouldn't be unbelievable looking at history.
According to measuringworth.com, $1 one hundred years ago would buy the equivalent of $24 of common retail goods and the equivalent of $99 of the time of an unskilled labourer. A time-traveller from 1914 would expect a "$1 menu" to be high quality dining, worth days' wages for the average Joe. Not so different to how the idea of a $100 menu seems to us today,
This seems like a big change - but even this is a small change by international standards.
The US dollar has historically been one of the world's most stable currencies, partly related to its use in international trading and its status as a reserve currency. In other countries, even countries with relatively stable economies, such changes do happen in a person's lifetime. Here in the UK, it's a cliche for elderly people to complain that "in our day", meals could be bought for sums of money that today would considered small change.
But even though it'd be perfectly believable, it might not happen. Beware of extrapolations that assume trends won't change (cartoon from XKCD):
Anything could change. The US dollar might not keep its current world status. Governments influence inflation, and may sometimes simply change currency values if they feel it's getting out of hand. For example, in 2005 Romania knocked 4 zeros off its currency. 10,000RON became 1RON overnight.
answered Dec 30, 2014 at 12:40
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$100s in code blocks looks weird, the formatting went strange when I had$not as code like this $\endgroup$ Commented Dec 30, 2014 at 13:00 -
1$\begingroup$ Mystery downvoter: downvotes with no comments don't help anyone. If there's a mistake or inaccuracy here, please help the community by sharing what it is. $\endgroup$ Commented Dec 30, 2014 at 17:49
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$\begingroup$ The 10,000R = 1R overnight even further destroys people's savings, since now it's official: all fixed fees, e.g., 5R driver license registration must be paid with 50,000R legally... $\endgroup$– user218Commented Dec 31, 2014 at 6:18
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Inflation can be seen as a tax on (uninvested) savings really more than anything else. In 100 years, a McDonalds Hamburger will cost \$100 (say), but you'll also see a nominal minimum wage of $400 an hour.
However, your $1000 savings account (without interest) that would today buy you 100 hamburgers, would in 100 years buy you 10. Interest of course will offset this some, but interest rates often are below inflation. As such, inflation can be seen as a tax on savings. As long as you don't just hold onto the cash as money under your mattress, and as long as inflation is 'normal' (say, under 10% per annum), you shouldn't be unduly harmed (and will somewhat be helped, if you're good at your job).
Ultimately, inflation is caused because it is easier to expand the economy if the amount of money slightly outpaces the growth in the economy - ie, if the economy grows at 5%, money available should expand at 6% or 7% (which will cause a small inflation rate, 1-2%). If the money supply only grows at 3%, economic (real) growth will slow some, because it will be harder to pay for things, borrow money, etc. Aiming to expand the money supply a bit more than the expected economic growth avoids that problem. Lowering the interest rate for bank lending (ie, the Federal Reserve rate in the USA) also has an effect in this regard (as it tends to allow the money supply to expand more easily in response to demand); this is why we've had extremely low Fed interest rates (nearly 0) in the US since 2008.
It also (depending on if you believe this part) may make it easier to deal with wages, because wage cuts are infrequent, but raises below inflation levels are effective wage cuts, and commonly occur for underperforming workers. This is a more controversial part of inflationary theory, but has strong supporters (Paul Krugman and his ilk).
What it means is if you are investing your money in the economy, it should grow with it - hopefully ahead of inflation - while money sitting in a bank will likely lag inflation (not always, as sometimes interest will outpace inflation, but frequently not - banks have to keep enough uninvested currency to meet reserve minimums, so they cannot pay full investment value for your money).
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$\begingroup$ Why should the long-term spread between the market interest rate (which does roughly move with inflation) and the rate on savings accounts vary with inflation? Doesn't that imply that banks' net interest margin is much higher in a high-inflation world? Why would that be the case - why don't banks compete away the extra profits? $\endgroup$ Commented Dec 30, 2014 at 20:30
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$\begingroup$ Lowering the Fed interest rate both lowers lending interest rates (which are often tied to it indirectly) and raises inflation (as it effectively expands the money supply). It is, after all, the main tool that Bernanke uses in raising inflation/avoiding deflation. The market interest rate does roughly move with inflation - it must be in the ballpark or nobody will lend - but it's fairly rough, and bank savings account rates are very much below the market interest rate. It has to price in the risk on bank loans, after all. $\endgroup$– JoeCommented Dec 30, 2014 at 22:08
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$\begingroup$ yes, there's a positive spread between savings account rates and market rates for many reasons, but my point is that there's no long-term reason to expect that spread to increase as inflation goes up; if it does, and it's not offset by lower fees or some implicit improvement in savings account rates, then more inflation is enabling banks to make windfall profits. I don't see why that would be the case. $\endgroup$ Commented Dec 30, 2014 at 22:36
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$\begingroup$ Banks are fairly immune to the monetary inflation they cause. They make their profits from the difference between income (loan interest), and expenses (loan defaults, payments to savers, dividends, costs, etc.). As they expand the money supply, they essentially grab a slice of it, independently of its size - their ability to change the size of that slice is relatively small, unless something fundamental changes in their operations. Securitised loans are one example of this - in which case they can get windfall profits for the short period until the consequent windfall losses occur. $\endgroup$– LumiCommented Dec 31, 2014 at 0:53
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No.
The price paid for any item in a market based economy is loosely a direct function of the total quantity of money and an inverse function of all the transactions that that quantity of money is used for.
Inflation can consequently arise from 2 separate causes - increases in the total quantity of money, and decreases in the total quantity of production.
Owing to the way the banking system operates, the money supply typically increases over time. For example, the USA´s money supply over time looks like this:
As the money supply expands, prices increase (inflation), but that´s prices for everything, including labour. So at the point in time when the money supply expansion causes McDonald´s burgers to cost $100, average salaries would have increased to a similar degree. Money hasn´t become worthless, it´s just had a few 0´s tacked on its quantity. If you flip this paragraph around, then the value of money itself, is a function both of its total quantity, and the total amount of economic activity that it is being used as a unit of exchange for.
It´s also possible that production could dramatically decrease, for example if harvest failure led to food shortages. In that case, the price could increase to 100 dollars or more, but that would be an indicator of scarcity. Conceivably, a vegetarian dominated government could also legislate beef consumption to be illegal, in which case the black market price could well become $100, in this case reflecting a presumably artificial scarcity.
Note though, that this behaviour both of the banking system in expanding the money supply, and the economy in expanding or contracting production does mean that the time value of money is more or less continuously decaying. So in the sense of putting a $100 note under the mattress for a hundred years, then yes, that particular amount of money will become worthless or nearly so, because whatever fraction of the total money supply it was at T, it will be substantially less in T+100 years.
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$\begingroup$ In order for a decrease in the quantity of production to affect inflation, it would have to be across the board (economic contraction): simply a beef shortage wouldn't have a significant effect on true inflation (it might affect the CPI, but that's an artificial measure). Consumption would shift from beef as prices rose, so while the nominal price of beef would rise, the total food expenditures wouldn't rise very much. $\endgroup$– JoeCommented Dec 30, 2014 at 20:18
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$\begingroup$ I think we have to unfortunately accept that inflation is defined as changes in the CPI - since that´s the common usage - although I agree with the distinction that you´re making, and it´s an important one. Unfortunately, due to the complete absence of statistics, we have no empirical data on what real price behaviour would be if measured across every single item which was purchased with a monetary transaction. $\endgroup$– LumiCommented Dec 31, 2014 at 0:55
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I wish to dissent from some of the suggestions in the answers above.
First, inflation need not be uniform, and it has a political component. So the idea that rising hamburger prices will be offset by rising wages is by no means certain. At present, we see in many areas of the nation rising costs in housing, education, and other "essentials" that are not offset by rising wages. In some markets, like Manhattan where I live, growing income inequality can mean "inflation" inequality. Stagnant wages meet rising upper-tier incomes and rising property prices. So in certain possible worlds your hamburger might become unaffordable to wage-earners.
When you ask if inflated money can become technically "worthless," the answer is yes. In the Weimar hyperinflation, there were cases of money being burned for fuel because its value as "money" was less than its value as "paper." Since paper is about as intrinsically valueless as a monetary medium can get, one might say the state certification of "money" had become "worth less" than any practical medium and thus "worthless."
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Shadowstats.com states an annual inflation rate for the USD at present at over 10%. This is accelerating to the upside.
Here's something you missed: Historically fiat monetary systems have a 100% failure rate.
L.
