Imagine if you earned the same salary today but lived in the time of your grandparents. There’s a good chance that you would be the wealthiest person in the neighborhood, but how can this be? Purchasing power explains the difference.
What Is Purchasing Power?
Purchasing power expresses the amount of goods one is able to buy with a given amount of money, or currency. The value of currency fluctuates with interest rates, both long and short term. Inflation occurs when a currency’s purchasing power decreases. Additionally, the central banks of the world aim to keep inflation under control, or at healthy levels.
For example, rampant inflation causes businesses’s materials to increase, thus driving up the price. However, the consumer does not not typically experience a pay increase that matches uncontrollable inflation. This situation occurred in the past after wars and leaves countries and economies devastated.
Analyzing Purchasing Power
How does one know when inflation increases or decreases? A government agency known as The U.S. Bureau of Labor Statistics (BLS) keeps a record known as the Consumer Price Index (CPI). This number records historical weighted average of prices of a basket of goods and services. Furthermore, this number serves as a benchmark in comparing inflation numbers over time. More CPI here.
Also, economic cycles impact purchasing power. For example, the world experienced a financial crisis starting in 2008. In order to ease consumer and investor fear and increase liquidity, central banks kept borrowing rates near 0. This theory assumes that the circulation of money will continue, as businesses continue to produce and consumers continue to spend. Additionally, if this scenario plays out on a global scale, all economies will control inflation, leaving no one in a a solvency crisis.
Purchasing power varies with different economic cycles. For example, housing prices were certainly cheaper a 30 years ago, but so were wages. As long as inflation remains stable, consumers’ purchasing power stays relatively constant.