Is inflation a problem that should concern retired citizens? The answer is, in the best tradition of economic thinking, yes and no. Plus, I must add, it all depends....
Inflation is a general rise in prices. Not all prices may rise at the same rate, but the tendency is for an upward movement across the board.
Inflation is not a concern for a person whose income and assets are rising at approximately the same rate as prices. If, however, your income is fixed and prices are rising, you will have to cut back on your purchases. That means less beer and/or less pizza; your quality of life declines.
Today we have inflation running at about 2 percent per year. By most standards this is a low rate of increase in prices.
But a 2 percent decrease in buying power, year after year after year, is not insignificant. In the first year, that’s $200 in lost buying power on a fixed income of $10,000. Over five short years, that’s a cumulative loss of $3,081 in goods and services for a person with that fixed $10,000 annual income.
For the economy at large, a 2 percent inflation rate is considered benign. Because the price index does not do a good job of capturing quality improvements, the actual rate of inflation may be considerably
lower. Nonetheless, for the person who is not buying new products, but getting along with an unchanging market basket of goods, this annual erosion of buying power is serious.
Social Security payments are supposed to be adjusted for inflation, but there is disagreement over which measure of inflation to use. For those on fixed annuities, without an inflation rider, there is only the prospect of continuing decreases in buying power as even moderate inflation proceeds.
The best forecasts of inflation now circulating indicate that we will continue in the 2 percent range for the next three years. Why? Unemployment remains high and incomes are not rising. Therefore, firms are constrained from raising prices.
Yet shadows of prior policies remain on the horizon. The Federal Reserve System helped pull us out of the recession by expanding the money supply. More money is the ultimate cause of inflation. Not labor unions or oil companies or commodity prices or hoarding, but available money is the root of inflation.
Can the Fed reduce the money supply as the economy improves? No one knows.
One school of thought says reversing the steps taken to increase the amount of money in the banking system will put the brakes on any inflationary pressure. Another school of thought denies we know how to use the brakes since we never had a monetary stimulus of this magnitude before.
Whether a specific individual will be hurt by inflation depends on the sources of income a person enjoys. If you have an IRA or some other asset tied to the price of stocks, you are better off than if you just have a savings account at the bank. Stock prices generally rise as dividends rise, and those payments most often rise when a firm’s revenues rise, as from inflation.
Fundamentally, inflation steals buying power from the saver, the person who avoids risk, the person with limited alternatives. As more of us retire and fit that profile, inflation becomes more of a threat to the public’s well-being.
Morton Marcus is an economist, formerly with the Indiana University Kelley School of Business.