Inflation rate vs. Growth rate

Wade A. Barker By Wade A. Barker, 7th Sep 2011 | Follow this author | RSS Feed | Short URL http://nut.bz/ml6y69gc/
Posted in Wikinut>Business>Investment

This article will compare and contrast the rate of inflation and the rate of growth.

Inflation rate vs. Growth rate

Overview
According to Investopedia.com, inflation is the rate at which the general level of prices for goods and services rise, and, subsequently, purchasing power falls. Investors realizes the growth rate of their initial investment when the investment shows gain over a specified period of time. The investment realizes the gain either through paid dividend or through the underlying investment having a price increase. The growth rate provides the investor with gain and the inflation rate counteracts that gain by reducing the amount of purchasing power.

Function
Investors save their money and look for investments that will pay them a recurring dividend or have growth in the future. Those future dividends and growth get eroded if the cost of living increases. If the investment paid 10 percent and the cost of goods increased 12 percent, the investor has lost 2 percent in purchasing power over the investment term. If the investment returned 10 percent and the cost of living increased only 3 percent, then the investment has an inflation-adjusted return of 7 percent (10 percent minus 3 percent).

Time Frame
Investors have a multitude of different time frames. Some invest to buy a new car in five years, while others have an intent of retiring in 15 years. The time frame of the investment term will dictate to the investor what inflation metrics they should examine. Ultimately, inflation becomes a supply and demand issue. Inflation occurs when too many potential buyers bid up the price of a limited number of goods and services.

Warning
If inflation has a negative effect for an investor’s growth rate, then deflation would seem to have a positive effect. Deflation has a positive impact for the investor in the short-term, as they can buy investments for depressed prices. However, the negative long-term effects of deflation on the economy overshadow any type of short-term benefits. Investopedia.com describes deflation as a general decline in prices, often caused by a reduction in the supply of money or credit. The opposite of inflation, deflation has the side effect of increased unemployment since the demand in the economy has shrunk, which can lead to an economic depression.

Benefits
A certain amount of inflation has a healthy benefit for an economy. Inflation indicates that the economy has grown, and for an investment to grow, typically the underlying economy should be healthy and growing as well. The central bank of a country will try to balance the economy to ensure inflation has a moderate effect. The central bank will use tools such as interest rates, discount rates, and reserve requirement within the banking system to control the both the supply of money and the cost of money.

Considerations
An investor should take care in what inflation metrics they examine and how these metrics will effect them. Most government inflation gauges exclude the cost of housing. When a corporation examines a city for expansion, they will look at the cost of living. The major component in the cost of living usually comprises the cost of housing. Therefore, when an investor examines the budget required to retire, the cost of housing will emerge as the primary factor.

Reference
Investopedia.com
Investopedia.com

Tags

Economic Growth, Growth, Growth Rate, Inflation, Inflation Rate

Meet the author

author avatar Wade A. Barker
Wade Barker has over 15 years of experience in the stock market, the U.S. and world economies. He worked for a technology fund of a large mutual fund company managing $11 billion.

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Comments

author avatar Alicia Badilla
9th Sep 2011 (#)

Hi Wade, I also worked for a firm that manages a lot of money. Are you still with them? Cheers

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