Anticipated Inflation: Definition & Overview

Instructor: Michael Cozad

Michael is a financial planner and has a master's degree in financial services.

Explore how anticipated inflation can contribute to eroding purchasing power over time. Learn about how the average annual inflation rate from 1914 to 2013 was 3.3% and how this can affect consumers and businesses.

Definition

Anticipated inflation is the percentage increase in the level of prices over a given period that is expected by participants in an economy. Think of a loaf of bread or some other type of consumer staple that you regularly purchase when you shop. It is fair to say that, over time, the price of that staple will increase. It's unlikely that bread cost the same twenty or thirty years ago as it does today.

Importance of Predicting Inflation

Predicting that inflation will occur over a given period of time can assist consumers and businesses in being proactive so that purchasing power can remain constant. Purchasing power can be described as being able to purchase the same amount of items in the future as you can today. For example, if a business anticipates that in the next five years, it will continue to use the same amount of widgets, it may take steps to ensure it has the funds available to continue purchasing the same amount of widgets over the next five years. Businesses can take other steps, too, such as increasing prices of the items they sell so that their revenues increase with their expenses.

Think back to you, as the consumer. If you anticipate retiring in thirty years, it's likely the price of items you purchase will increase over time (perhaps at a rate of 3% per year). If you were saving for retirement, you may not want to set aside money in a non-interest-bearing account (think of a checking account that does not typically pay monthly interest). Over time, your purchasing power would decrease. It's possible that other types of savings vehicles will help better meet your goals.

The average annual inflation rate from 1914 to 2013 was 3.3%.

The Changing Price of Bread
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Calculating the Impact of Inflation

Let's look at an example. Say that in 5 years, you wish to purchase a new car. You anticipate that inflation will be 3% per year on the purchase price of that particular car model. The cost of the car today is $15,000. We can then calculate the future cost of the car by using the following formula: p x (1+(i))^n = future cost

where:

p = purchase price today

i = anticipated inflation per year

n = number of years

$15,000 x (1+(.03))^5 = $17,389.11

You now know that because of anticipated inflation, you need to save about $2,400 more than you would have otherwise. Had you forgotten about anticipated inflation, you would have needed to borrow the $2,400 when you went to purchase the car!

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