Inflation and Purchasing Power

How to use Inflation Calculator

1. 1
   Enter an amount and a rate. Use a long-run average of 2 to 3%, or a figure you want to test.
2. 2
   Set the period. The effect is unremarkable over three years and severe over thirty.
3. 3
   Add any interest earned. This is what turns the result into a real return rather than a nominal one.

About calculating the effect of inflation

Inflation is compound interest running against you, and it obeys exactly the same arithmetic. A three percent annual rate does not remove three percent of your purchasing power over a decade; it removes about twenty-six percent, because each year applies to what remains. Over thirty years at the same rate, money keeps around forty percent of what it could buy at the start. The rule of 72 works here as well as it does for savings, and is arguably more useful in this direction because it converts a rate into something concrete. Divide 72 by the inflation rate and you have the number of years until prices double — twenty-four years at three percent, twelve at six, a little over seven at ten. Anyone who has heard an older relative describe what things used to cost has heard that arithmetic from the other end. The distinction that matters most in practice is between nominal and real returns. A savings account paying two percent during five percent inflation shows a growing balance on every statement while losing three percent of its value a year, and nothing about the statement reveals it. The correct way to compute the real figure is to divide the growth factor by the price factor rather than subtracting one rate from the other; the subtraction is a decent approximation at low rates and drifts noticeably once either number gets large. It is also worth knowing that a published inflation figure is an average over a representative basket, and household experience diverges from it whenever spending is concentrated in categories moving faster than the headline.

Frequently asked questions