Vol. XXXI
No. 12
Published by
AMERICAN INSTITUTE
ECONOMIC
EDUCATION
BULLETIN
December
for
ECONOMIC RESEARCH
Great Barrington, Massachusetts 01230
1991
A GUIDE TO PRICE INFLATION
A dollar isn't what it used to be. As measured by changes
in the Consumer Price Index (CPI), the general price level
has increased more than eight times since 1930. To buy the
same value of goods and services that a dollar commanded
in 1930 you now need $8.15; today's dollar buys only what
12 cents did 60 years ago.
Over shorter periods prices have increased less rapidly,
but the cumulative effect of even moderate price inflation
can be severe — perhaps more severe than many people
may realize. For example, during the past 5 years, when
price inflation averaged 4.4 percent per year and was widely
regarded as being "under control," the purchasing power of
the dollar dropped by 20 cents.
As shown in the tables on the following pages, the rate of
price inflation has varied over the years and has fluctuated
with economic cycles, but the long-term trend has been
upward. During the 43 years ending 1991, the increase in
the CPI has been as follows:
Period
1948-1962
1962-1976
1976-1991
CPI
+26.1%
+91.4%
+136.8%
The effect of these price increases has been felt unevenly
by those who hold dollars and use them for transactions. In
general, individuals or businesses "locked in" to fixed-dollar contracts suffer or benefit the most when price inflation
exceeds expectations. The "winners" are those who contracted to pay out fixed amounts of dollars in the future,
since they pay with dollars of reduced purchasing power.
The "losers" are those who are obligated to accept future
payments of dollars.
Past "winners" include long-term borrowers with fixedrate contracts. These include not only private borrowers (for
example, the home buyers of the 1960's who took out 20year mortgages at 6 percent interest), but also public borrowers, most notably the Federal Government (which is still
paying 3.5 percent interest on bonds issued in 1960).
The "losers" have included the savings and loans institutions that "borrowed short and lent long" in the 1960's and
1970's, and many individuals who purchased Government
bonds. Pensioners and annuitants who receive fixed-dollar
incomes have also suffered from the degradation of the
currency.
Other winners and losers in the "inflation game" and their
gains and losses are more difficult to identify. This is partly
because price increases attributable to the excess creation of
purchasing media do not affect all goods and services to the
same extent. People who buy the items whose prices increase
fastest (such as medical and educational services in the 1980's)
suffer a relatively larger erosion in the purchasing power oí
their dollars; people who supply these items may actually
gain. In addition, some items, such as financial assets and
real estate, are not directly included in standard statistical
measures of price inflation, and thus it is difficult to gauge
the impact of their price changes on the "cost of living."
Moreover, price inflation affects people differently nowadays than it did years ago, due to the increased use of
"inflation hedges." Cost-of-living adjustments (COLAs), "inflation-indexing," and adjustable-rate loans have shifted some
of the cost of price inflation away from those who traditionally were harmed by it to those who used to benefit from it.
For example, adjustable-rate loans have reduced both the
potential losses to lenders and the gains to borrowers in the
event that prices increase faster than expected.
However, it is virtually impossible to protect all of one's
financial transactions, income and assets from the effects of
price inflation. Most employers offer COLAs to employees
only on an ad hoc basis, if at all. The adjustments are sometimes inadequate, and there is no guarantee that they would
be provided if price inflation returned to the "double digits."
Company-sponsored pension benefits are rarely if ever adjusted, and annuities are not indexed at all. Federal income
tax brackets are indexed annually, but many deductions and
credits are not (e.g., the maximum IRA deduction, which
has been fixed at $2,000 since 1981; if it were indexed it
would now be $3,000).
Long-term investors, in particular, are still very vulnerable to accelerating price inflation. On the one hand, capital
gains are not indexed on U.S. tax returns, even though many
such gains simply reflect rising prices and not any real
income gains. On the other hand, investors who buy longterm fixed-rate bonds are essentially gambling that the "inflationary expectations" reflected in their interest rate will
be accurate. If prices increase faster than the "conventional
wisdom" anticipates, long-term investors stand to lose —
and long-term borrowers stand to gain.
In this respect, it is notable that the largest and fastestgrowing borrower in the United States is the Federal Government. Current U.S. public debt stands at $2.4 trillion, or
48 cents for every dollar of GNP. Interest payments on this
debt have increased sharply in recent years. In 1990 the
Government paid $184 billion in net interest. These outlays
accounted for 14.7 percent of total Federal spending, compared to 8.5 percent in 1979. In relation to Gross National
Product, interest outlays during this period increased from
1.7 percent to 3.5 percent.
As the burden of financing this growing debt increases,
so will the pressure to "inflate it away." And as long as
politicians and money managers have the power to issue
currency by fiat, this option will be available to them.
If and when this happens — and there has never been a
fiat currency that did not eventually devolve into worthlessness — the impact on income and wealth that is not pro-
Table A
TODAY'S DOLLARS
$1
$20
$500
$1,000
and their equivalent purchasing power
in earlier years:
1920
$0.15
0.13
0.12
0.13
0.13
1925
0.13
26
0.13
27
0.13
28
0.13
0.13
29
1930
0.12
31
0.11
32
0.10
33
0.09
34
0.10
1935
0.10
36
0.10
0.11
37
38
0.10
39
0.10
1940
0.10
41
0.11
42
0.12
43
0.13
44
0.13
1945
0.13
46
0.14
47
0.16
48
0.18
49
0.17
1950
0.18
51
0.19
52
0.20
53
0.20
54
0.20
1955
0.20
56
0.20
57
0.21
58
0.21
59
0.21
1960
0.22
61
0.22
62
0.22
63
0.23
64
0.23
1965
0.23
66
0.24
0.25
67
68
0.26
69
0.27
1970
0.29
0.30
71
0.31
72
73
0.33
74
0.36
1975
0.40
76
0.42
0.45
77
78
0.48
0.53
79
0.61
1980
81
0.67
82
0.71
0.73
83
0.76
84
1985
0.79
0.81
86
0.84
87
0.87
88
0.91
89
0.96
1990
1.00
91
21
22
23
24
$2.94
2.63
2.46
2.51
2.52
2.58
2.60
2.55
2.52
2.52
2.45
2.23
2.01
1.90
1.97
2.02
2.04
2.11
2.07
2.05
2.06
2.16
2.40
2.54
2.59
2.65
2.87
3.28
3.53
3.50
3.54
3.82
3.91
3.94
3.95
3.94
4.00
4.13
4.25
4.28
4.35
4.40
4.45
4.51
4.56
4.64
4.78
4.91
5.11
5.39
5.71
5.95
6.15
6.53
7.25
7.91
8.37
8.91
9.59
10.67
12.11
13.37
14.19
14.65
15.27
15.81
16.12
16.71
17.39
18.22
19.21
20.00
$74
66
62
63
63
65
65
64
63
63
61
56
50
47
49
50
51
53
52
51
52
54
60
64
65
66
72
82
88
87
88
95
98
98
99
99
100
103
106
107
109
110
111
113
114
116
119
123
128
135
$147
143
149
154
163
181
285
298
307
327
362
198
209
223
240
267
396
418
445
480
533
303
334
355
366
382
395
418
435
456
606
668
709
732
763
791
806
835
869
911
480
500
1,000
403
131
123
125
126
129
130
128
126
126
123
112
100
95
98
101
102
106
104
102
103
108
120
127
129
132
143
164
177
175
177
191
195
197
198
197
200
207
212
214
217
220
222
225
228
232
239
245
256
269
960
tected by "inflation hedges" (including
"safe" Government bonds) will be severe. In the meantime, as illustrated in
the accompanying tables, even if the recent trend of "moderate" price inflation
persists for some time the effect on the
buying power of the dollar will be substantial. And chronic uncertainty over
what the dollar will be worth in the future will continue to confound attempts
at long-range financial planning.
CHANGES
IN THE PURCHASING POWER
OF THE DOLLAR SINCE 1920
The two tables on this page illustrate
the impact of price inflation on the purchasing power of the dollar over the past
70 years. The figures are based on the
Consumer Price Index, a statistical measure that is imperfect but is widely viewed
by economists as the best available approximation of the "cost of living."
Table A shows dollar amounts for
each year since 1920 that had the same
buying power as one dollar, $20, $500,
and $1,000 in 1991. In other words, how
much you would have needed in earlier
years to buy what one dollar, $20, etc.
bought in 1991.
For example, in 1975 you needed only
40 cents to buy what one dollar could
buy in 1991. You needed only $7.91 to
buy what $20 buys today. Because the
general price level was less than half
what it is today, far fewer dollars were
needed to purchase the same amount of
goods and services.
In 1945, when prices were even lower,
a mere 13 cents had the same buying
power as a dollar in 1991, and $132 had
the buying power of today's $1,000.
Thus, in terms of the goods and services
it could purchase, the 1945 equivalent of
today's $20,000 salary was $2,640
(20 × $132).
Table B illustrates the shrinkage in
the dollar's buying power somewhat differently. It shows the equivalent purchasing power in 1991 of one dollar, $5, $20,
and $1,000 in each year since 1920. In
other words, how much currency one
needs today to match the buying power
that these amounts had in earlier years.
For example, to match the buying
power that one dollar provided in 1975
you would need $2.53 today. To match
the buying power that a dollar had in
1945 you would need $7.56.
The first column in Table B essentially shows how much general prices
have increased over the years. Since
1945, for example, prices have increased
more than seven times (7.56 times, to be
more precise). Just since 1987 prices have
increased 20 percent, and it now takes
$1.20 to match the buying power that
one dollar had 4 years ago.
2
Table B
YESTERDAY'S DOLLARS
$ 20
!% 500 $1,000
$1
and their equivalent
purchasing power today:
$6.79 $135.83
7.62
152.34
22
8.12
162.35
159.49
23
7.97
7.94
24
158.87
1925
154.94
7.75
26
7.69
153.77
7.84
156.73
27
28
7.93
158.56
29
7.93
158.56
163.00
1930
8.15
31
8.96
179.12
32
9.96
199.27
33 10.53 210.59
34 10.16 203.24
1935
9.91
198.30
36
9.82
196.39
37
9.48
189.53
38
9.66
193.13
39
195.44
9.77
1940
9.70
194.05
41
9.24
184.81
42
8.35
167.01
43
7.87
157.34
44
7.73
154.65
1945
7.56
151.21
46
6.98
139.55
47
6.09
121.82
48
5.66
113.19
49
5.72
114.31
1950
5.65
113.04
5.24
51
104.76
52
5.12
102.39
53
5.08
101.62
54
5.06
101.24
1955
5.07
101.49
56
5.00
100.00
4.84
57
96.79
58
4.71
94.22
59
4.67
93.36
1960
4.60
91.99
61
4.55
90.96
62
4.50
89.96
63
4.44
88.78
64
4.38
87.63
1965
4.31
86.24
66
4.19
83.76
67
4.07
81.50
68
3.91
78.21
69
3.71
74.23
1970
3.50
70.08
71
3.36
67.19
72
3.25
65.04
73
3.06
61.23
74
2.76
55.18
1975
2.53
50.56
76
2.39
47.80
77
2.25
44.90
78
2.09
41.71
79
1.87
37.49
1980
1.65
33.02
81
1.50
29.92
82
28.19
1.41
83
1.37
27.31
84
1.31
26.20
1985
1.26
25.29
86
1.24
24.82
87
1.20
23.94
88
23.00
1.15
89
21.95
1.10
1990
1.04
20.82
91
1.00
20.00
1920
21
$3,396 $6,792
3,808
7,617
4,059
8,118
3,987
7,975
3,972
7,943
3,874
7,747
3,844
7,689
3,918
7,837
3,964
7,928
3,964
7,928
4,075
8,150
4,478
8,956
4,982
9,963
5,265 10,530
5,081 10,162
4,957
9,915
4,910
9,819
4,738
9,477
4,828
9,656
4,886
9,772
4,851
9,702
4,620
9,240
4,175
8,350
3,933
7,867
3,866
7,732
3,780
7,560
3,489
6,978
3,046
6,091
2,830
5,660
2,858
5,715
2,826
5,652
2,619
5,238
2,560
5,119
2,541
5,081
2,531
5,062
2,537
5,075
2,500
5,000
2,420
4,840
2,355
4,711
2,334
4,668
2,300
4,599
2,274
4,548
2,249
4,498
2,219
4,439
2,191
4,382
2,156
4,312
2,094
4,188
2,037
4,075
1,955
3,911
1,856
3,711
1,752
3,504
1,680
3,359
1,626
3,252
1,531
3,062
1,379
2,759
1,264
2,528
1,195
2,390
1,123
2,245
1,043
2,085
937
1,874
826
1,651
748
1,496
705
1,410
683
1,366
655
1,310
632
1,265
620
1,241
599
1,197
575
1,150
549
1,097
521
1,041
500
1,000
Both tables make clear the impact of
price inflation on fixed-dollar incomes.
For example, suppose you retired in 1977
with a fixed company pension of $1,000
per month. By 1991, that $1,000 no
longer bought the same amount of goods
and services that it did when you retired.
In fact, $1,000 in 1991 bought only what
$445 would have purchased in 1977 (see
Table A). This drop in the purchasing
power of your pension is the same as it
would be if prices had remained steady
but the company had cut your pension to
$445. Actually, the prices of goods and
services more than doubled — and to
match the purchasing power that your
$1,000 pension provided in 1977 it would
have to be $2,245 in 1991 (see Table B).
On the other hand, the tables also show
how debtors may benefit from price inflation. Suppose you borrowed $1,000 in
1985 and immediately spent it on goods
and services. If you repaid the principal
in 1991, your $1,000 payment effectively
"cost" you, in terms of goods and services forsaken to repay the debt, less than
$1,000, because of the 26 percent increase in general prices since 1985. In
fact, your $1,000 payment is the equivalent of only $791 in 1985 dollars (see
Table A). To repay the same purchasing
power that you borrowed 6 years earlier,
your payment in 1991 should be $1,265
(see Table B).
Of course, the debtor's gain is the
creditor's loss. After adjusting for price
WHAT YOUR DOLLARS WILL BE WORTH
if the price changes over the next 30 years
match i the annual changes from1961-91.
'
Year
$1
1991
1.00
0.99
0.98
0.96
0.95
0.92
0.90
0.86
0.82
0.77
0.74
0.72
0.67
0.61
0.56
0.53
0.49
0.46
0.41
0.36
0.33
0.31
0.30
0.29
0.28
0.27
0.26
0.25
0.24
0.23
0.22
92
93
94
95
1996
97
98
99
2000
01
02
03
04
2005
06
07
08
09
2010
11
12
13
14
2015
16
17
18
19
2020
21
$20
20.00
19.78
19.52
19.27
18.96
18.42
17.92
17.20
16.32
15.41
14.77
14.30
13.46
12.13
11.12
10.51
9.87
9.17
8.24
7.26
6.58
6.20
6.01
5.76
5.56
5.46
5.26
5.06
4.83
4.58
4.40
$500
500
495
488
482
474
460
448
430
408
385
369
358
337
303
278
263
$1,000
1,000
989
976
963
948
921
896
860
816
770
739
715
229
206
182
164
155
673
607
556
526
494
459
412
363
329
310
150
300
144
288
139
136
278
247
273
263
132
126
121
253
114
110
229
220
241
PURCHASING POWER OF THE DOLLAR, 1920=100
200.0
100.0
50.0 -
25.0 -
12.5
1920 '25
inflation the lender is effectively getting years of the 1980's, and shows no sign
back only $791 of the $1,000 he lent. of stopping.
(Theoretically, the lender could offset his
loss on the principal by charging a rate
WHAT WILL THE DOLLAR
of interest sufficiently higher than the
BE
WORTH IN THE FUTURE?
rate of price inflation, but the difficulty
is in accurately forecasting what that rate
The record of past price inflation is
will be.)
clear. What about the prospects for the
The extent to which gains on assets
reflect generally rising prices rather than
W H A T THE PRICE LEVEL WILL BE
real income also is clear. Take the case
if the trend from 1961-9 r
is repeated in 1991-2021 .
of an investor who bought a share of
stock in 1979 for $12 and sold it in 1991
Year
$20
$500 $1,000
$1
for $50. His nominal capital gain is $38
1991
1.00
20.00
500
1,000
($50 - $12). As shown in Table B, how92
506
20.22
1,011
1.01
93
1.02
20.49
512
1,025
ever, between 1979 and 1991 the general
94
1.04
20.76
519
1,038
price level increased 87 percent, and one
95
1.05
21.09
1,055
527
needed $1.87 to match the buying power
1996
1.09
543
1,086
21.72
that one dollar had in 1979. Adjusting
97
1.12
22.32
558
1,116
the original stock price for this price in98
1.16
581
23.26
1,163
flation gives a value of $22.44
99
24.51
1.23
613
1,225
($12 × 1.87), and thus the real income
2000
1.30
25.96
649
1,298
gain is not $38 but $27.56 ($50 - $22.44).
01
1.35
27.08
677
1,354
Under current U.S. law nominal capi02
1.40
27.97
699
1,398
03
1.49
29.71
743
1,486
tal gains are fully taxable as income, even
04
1.65
32.97
824
1,648
though they may not represent real in2005
900
1.80
35.98
1,799
come. (In the example above, the inves06
951
1.90
38.06
1,903
tor would owe income tax on $38, even
07
2.03
40.51 1 ,013
2,026
though his real income was only $27.56.)
08
2.18
43.62 1 ,090
2,181
This system is both unfair and ineffi09
48.53 1 ,213
2,426
2.43
cient, in that it encourages people to hold
2010
2.75
55.09 1 ,377
2,754
stocks they would otherwise sell, in or11
3.04
60.80 1 ,520
3,040
12
3.23
64.53 1 ,613
3,227
der to avoid paying taxes on nominal
13
66.61 1 ,665
3,330
3.33
gains. In this respect, it would be prefer14
3.47
69.44 1 ,736
3,472
able to index capital gains for price in2015
3.60
3,596
71.92 1 ,798
flation.
76
3.67
73.30 1 ,833
3,665
The accompanying chart shows the
17
3.80
75.98 1 ,900
3,799
same information represented in Tables
18
3,954
3.95
79.08 1 ,977
A and B. The continuous downtrend in
19
4.14
82.88 :>,O72
4,144
the purchasing power of the dollar is ap2020
87.37 ;>,184
4,368
4.37
4,548
21
90.96 I>,274
4.55
parent, even during the "low inflation"
3
THE PURCHASING POWER OF THE DOLLAR IN FUTURE YEARS
AT VARIOUS RATES OF PRICE INFLATION
Years
'98
'99 2000 '01
'94
'95
'96
'97
'93
Rate 1992
'02
3% $.97 $.94 $.92 $.89 $.86 $.84 $.81 $.79 S.77 $.74 $.72
.70
.68 .65
.79
.76
.73
.85
.82
.92
.89
4%
.96
.61
.58
.68
.64
.75
.71
.86
.82
.78
5%
.95
.91
.53
.59
.56
.75
.70
.63
.84
.79
.67
.94
.89
6%
.54
.51
.48
.58
.76
.62
.82
.71
.67
7%
.93
.87
.54
.50
.46 .43
.68
.63
.58
.86
.79
.74
8%
.93
.46
.42
.39
.55
.50
.84
.65
.60
.92
.71
9%
.77
.42
.39
.35
.56
.51
.47
.83
.75
.68
.62
10%
.91
11%
.90
.81
.73
.66
.59
.53
.48
.43
.39
.35
12%
.89
.80
.71
.64
.57
.51
.45
.40
.36
.32
future? What will the dollar be worth 5,10, or 15 years from
now? What will it be worth when you retire, or when your
children graduate from school?
If history repeats itself and the dollar loses value at the
same rate over, say, the next 30 years that it did over the past
30 years, the outlook is bleak indeed. The two tables on page
3 illustrate this scenario; they assume that the year-to-year
changes in the CPI over the period 1991-2021 will match
exactíy the changes recorded during 1961-1991.
If this were to happen, the purchasing power of today's
dollar could be expected to drop to 74 cents over the next 10
years (see table on left). A basket of goods and services that
costs $1,000 today would cost $1,354 in 2001. Twenty years
from now, in 2011, the dollar would be worth just 33 cents —
and you would need over $3,000 to buy what $1,000 buys
today (see table on right).
It is very unlikely, of course, that the future price trend
will exacüy replicate that of the past. Nevertheless, the illustration is instructive, since the period 1961-91 covers a wide
range of annual changes in the general price level, from the
2 percent increases of the 1960's to the "double digit" in-
'06
'07
'10
'11
'12
'04
'05
'08
'09
'03
$.70 $.68 $.66 $.64 $.62 $.61 $.59 $.57 $.55 $.54
.46
.44
.58
.56
.53
.51
.49
.47
.62
.60
.38
.36
.51
.48
.46 .44
.42
.40
.56
.53
.31
.44
.42
.39
.35
.33
.29
.50
.37
.47
.26
.24
.41
.39
.36
.34
.32
.30
.28
.44
.34
.23
.21
.20
.40
.32
.29
.27
.25
.37
.16
.30
.25
.23
.21
.19
.18
.36
.33
.27
.24
.14
.29
.26
.22
.20
.18
.16
.15
.32
.29
.26
.23
.21
.19
.32
.17
.15
.14
.12
.11
.29
.26
.23
.20
.18
.16 .15
.09
.13
.12
.10
crease of the late 1970's, to the "disinflation" of mid-1980's.
The projections for the next 10 years, it should be noted, are
based on the "good old days" of the l96O*s, when the average annual rate of price inflation was only 3.1 percent. At
that rate, the purchasing power of the dollar would drop a
full 25 cents by 2001.
The table on this page shows what the buying power of
today's dollar would be over the next 20 years at various
assumed rates of price inflation. If the rate at which the
dollar loses value remains a "moderate" 3 percent —and
given recent experience, this would seem to be a "lowball"
long-term forecast — it still will be worth only 64 cents by
the time the first "baby boomers" turn 60 (in 2006). In 20
years its buying power would be cut almost in half. On the
other hand, if price inflation accelerates, today's dollar could
be worth much less.
Unfortunately, there is no way to forecast accurately which
trend will prevail. In our view, however, as long as politicians face pressures to debase the currency and there is
nothing to prevent them from doing so, the possibility of a
reacceleration in price inflation remains a serious threat.
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