While the experience of the 1950′s and 1960′s indicates that a society can tolerate moderate inflation, rapid inflation such as we have experienced since the early 1970′s is another matter, for several reasons.
(a) Inflation imposes hardship on the economically weak
For those such as professionals, star professional athletes and members of strong labor unions, who have the economic power (bargaining power) to increase their incomes, inflation can be more of an irritation than a hardship. For many others, however, such as the unskilled, non-union workers and many office workers, it often proves difficult to increase incomes as fast as prices are rising, so that inflation poses a real threat to their standard of living. Generally, it can be said that inflation falls hardest upon those who are the least able to protect themselves – the economically weaker groups in society.
The people most severely affected by inflation are those on fixed incomes, that is, people who receive the same number of dollars of income year after year. As the purchasing power of their fixed income falls year by year due to inflation, their standard of living is driven steadily downward. The largest and most seriously affected such group is, of course, pensioners, whose pensions are fixed for the rest of their lives. Two other groups adversely affected are welfare recipients (whose benefits do not always keep up with inflation) and people living off investment income, such as interest. This latter group includes not only wealthy investors, but also widows living off the investment income earned through the investment of their husbands’ life insurance.
Thus, inflation generally tends to redistribute income within a society, with the economically powerful the gainers and the economically weak the losers.
The “72″ Formula
An idea of the impact of inflation on fixed incomes can be gained by using the “72″ formula:
If something (here, prices) is
increasing at a compound rate
of x percent per year, it will
double in 72 / x years.
For example, if the Consumer Price Index rises at 6 percent per year, it will double in 12 (72 / 6) years. Put another way, a 6 – percent annual rate of inflation will slash the purchasing power of a pensioner’s fixed income in half in 12 years.
Inflation at the 9 percent and 10 percent annual rates common since the mid-1970′s has a much more severe impact on fixed incomes, cutting their purchasing power in half in just 7 or 8 years. For a person considering early retirement at age 60, whose life expectancy may be 73, these rates of inflation can ruin a lifetime’s planning for a happy retirement.
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