Want to know how fast your dollar can lose its buying power? Here’s an easy way to find out, using the mathematical principle known as the Rule of 72.
All you have to do is take the number 72 and divide it by the rate of inflation. For example, if the rate of inflation is 2%, divide 72 by 2 and you get 36. This is the number of years it will take to cut your money’s value in half if inflation runs an average of 2% a year.
Scoot the average inflation rate up to 4%, and you will find that it takes 18 years to slice the value of your dollars in two.
And if the rate of inflation were to average 6%, you can say goodbye to half your dollars’ buying power in only 12 years.
How much inflation can (or should) you tolerate? If you are a working stiff, or you owe money, you should be able to get by with 6% inflation. Workers will likely garner enough cost-of-living raises to compensate for the upward march in prices. Debtors, of course, will be paying back their loans with cheaper dollars.
On the other hand, if you’re a retiree, a saver or a creditor, you would opt for 2% inflation or less. In other words, you would want your money to retain as much of its purchasing power as possible.
You would be in good company. Policy makers at the Federal Reserve generally prefer an inflation rate of 2% because it’s low enough so that people don’t pay much attention to it, yet high enough to keep deflation at bay, as I will elaborate below.
Congress would probably agree with a 2% inflation target — unless it results in too high an unemployment rate. However, some conservative pols would like to achieve the lowest inflation rate possible, even at the cost of higher unemployment. Both sides will see how these themes work out during the next elections.
Two-percent inflation is about as low as you can go without risking throwing the economy into reverse. On the other hand, some pundits believe that the Fed actually prefers more than 2% inflation because it gives them room to ease. This displays a lack of knowledge about how policy really works.
As I have observed in previous columns, monetary policy is better at restraint than it is at stimulus. The best analogy is that you can pull on a string but you can’t push on it. If the economy needs ease, fiscal policy is the tool you would use. It’s easier to cut taxes and to raise spending, which is what constitutes fiscal ease, than the reverse.
Right now, policy makers both here and abroad seem to think that the ideal inflation rate is 2%. Since the current rate of inflation here in the U.S. is less than this figure, it stands to reason that the Fed is unlikely to raise interest rates anytime soon. To do so would risk slowing inflation to the point where deflation becomes a real possibility.
In case you forgot, under deflation prices fall and the dollar actually gains in value. That said, after all the years we’ve experienced inflation, maybe falling prices might not be so bad after all.
美加华人聚集地区，为华裔长者提供亲切且方便的生活环境。(资料照片)
