Me and Money | A Personal Diary of Financial Adventures

8th Chapter | Purchasing power

As the sun dipped below the horizon, casting a warm glow over the quiet valley, Ada watched her parents and grandparents diligently tending their fields. She appreciated their attention, dedication and patience, realizing that, like growing a healthy crop, financial success required rhythmic discipline, long-term planning and anticipation of unforeseen events.

Eager to learn more and more, she looked forward to her friends.

Ada: Tell me what you know about inflation. I have been hearing this term on the news recently, over and over again. Lately, my mother has been getting more and more agitated and always says that we don't have enough money for food and household maintenance.

Daniel: I learned in school that inflation is characterized by an increase in the general level of prices of goods and services in circulation.

George: That's why inflation causes people's purchasing power to fall with the same unit of currency. In other words, inflation is a situation where our money doesn't buy as much as it used to because services and products now cost more.

Rareș: Aham... I heard my parents and grandparents talking recently about how milk and bread used to cost a lot less before. I guess that must be inflation. Right?

George: Yep. Let me give a more concrete example. In the year 2000, an audience member could buy a movie ticket for about 13-15 lei. Today, the average cost of a movie ticket is about 20-25 lei. In conclusion, 3 years ago, a person could buy two tickets for 30 lei, but today, with the same 30 lei, he can buy only one ticket. We can say that the currency has less value now than before, because of inflation.

Ana: However, why should we load our brains with such hard-to-understand terms?

Ada: It's just as complicated for me to understand, Ana, but I try to keep up with the boys. I hope that by exploring this topic we will be able to find out why our parents and grandparents find it hard to cope with current expenses at certain times.

Daniel: Yeah... inflation has an effect throughout the economy. Some people must limit the amount of luxury items they buy on a regular basis, while other people have to be able to cover the costs of everyday necessities like food and home maintenance, maybe even rent.

Ada: I understand, contextually, that businesses are selling fewer products, and the economy in general is suffering.

George: Exactly! I suggest we do an exercise in imagination. Suppose that over the next 10 years the prices of the products we buy double. If our parents' income also doubled, they would buy: A. Less than they buy now? B. The same as they buy now? C. More than they buy now?

Ada: It's like you're setting us up. I'm also afraid to answer, lest I get it wrong.

Daniel: Well, what do you think, are you getting a bad grade? I think we should ask each other questions like this more often. Answers may vary but the correct answer is ˝doubling our income will allow us to maintain our current standard of living even if the prices of the goods we buy double˝.

George: If I may, I challenge you again on this topic. Imagine that the interest rate on your family's savings account is 1% per year, and the inflation rate is 2% per year. After one year, with the money in your account your parents will be able to buy A. More than today, B. Exactly the same as today, or C. Less than today?

Daniel: First of all, the 2% inflation rate is higher than the 1% interest rate on personal savings, which means that those who saved money have lost purchasing power due to inflation. I think the correct answer is ˝less˝.

George: My mother showed me a practical way to understand inflation. Saving money is like taking a step forward from point A (where I am now financially) to point B (where I want to be). And inflation is like taking a step backwards. She also submitted to me that inflation increases the price of goods and services and erodes the interest earned on savings and investments, especially low interest accounts.