We have heard of inflation, but what is its effect? A dollar doesn’t buy what it used to. But what does that mean? I bought a house in 1988 for $97,000. If I had to buy it today with a weaker dollar, how much would it cost?
The answer requires finding the inflation rate for each year and multiplying them all together. So for 1988 to 1989 the inflation rate was 4.82%. That is 4.82 per one hundred. In one year you have the current value plus the inflation increase. So multiply by 1.0482 to get the new value. For each year you find the inflation rate, add to one and multiply. It is tedious to do this by hand.
There is a website that will do all this for you. Go to USinflationCalculator.com. My 1988 $97,000 purchase would cost $184,411.51 this year. My house isn’t actually worth this amount. Inflation is an average number that is useful on the average. A particular item can vary vastly in value. The housing crisis has lowered home prices, while fuel and food prices have risen. The prediction is not that far off, and may even be a little low. So perhaps inflation hasn’t caught up with home prices, or the housing crisis is not done lowering home prices to meet inflation. Neither has to be true. Housing prices have other factors that influence them, but consider both possibilities.
Inflation is useful for understanding the past, and predicting the future. If I save or invest my money, estimating inflation can inform my goals on how much I should target as a goal for my nestegg. If in 1988 I had wanted to save to buy a house in the future, I might have predicted that $184,000 might be how much I will need, but more likely I will have a rough number to aim for. As each year passes, and I see what the actual inflation rate was, I can adjust my rough guessing.