We’re hearing about inflation a lot now. The classic definition is ‘too much money chasing too few goods’. We don’t have inflation right now despite what you’re hearing out there. If you’re shopping, you know that. You know you can get a deal on a house, on a car, on clothing—all of those things are on sale. Now for my older clients, they think we have inflation because they’re not purchasing those things right now. They’re not buying new furniture, new houses, new cars. They’re seeing their grocery bills go up, and they see gasoline going up; and they think, “Oh my goodness, inflation.” But we don’t have those conditions.
It is measured by the government. It’s measured by something called the CPI Index, which is the Consumer Price Index. This measures the change in prices in a typical basket of goods that we might buy. There is a little bias in there, because it’s only adjusted every two years. We really look at the real return that we earn on our money. But we tend to focus, as consumers, on our nominal return, which is our stated return. We hear what CDs are paying down at the bank, and we forget that that factors into the inflation and the real rate of return. So if you have a 3% return on your CD, and we have 3% inflation, then your real return is really zero.
We do know that inflation averages over the long haul at about 3% a year, but, again, we don’t have those conditions right now. In fact, we are concerned about deflation—actually, prices falling. Inflation is linked to interest rates, so as inflation goes up, interest rates go up. So be careful what you ask for when you look for higher rates on your CDs. That means all those prices will go higher as well.
High inflation is really bad for growth. If it gets so high, then what will happen is we’ll spend all of our money now, because we know it’s not going to be worth as much a year from now.
In these conditions, with very low or now inflation, then that means your real return is still in the positive territory, and that’s a good thing.
Of course, we always hear back in the late 70s and early 80s, we had double digit CD rates. But we had double digit inflation too. We had 10%, 13%, 14% inflation. We can’t imagine that right now. So just remember, low inflation and low CD rates will go together. It’s going to track your interest rates. Concentrate on the real rate of return, which is what you earn after inflation.
Deflation may mean lower prices for goods, but it’s not necessarily a good thing, because it can really drag our economy down. We want to have just a little bit of inflation. But, of course, the Federal Reserve is always watchful we don’t get carried away. So maybe down the road we’ll have inflation, but not now.