Inflation and Purchasing Power: What Your Money Buys Over Time

How inflation is measured

In many countries an official consumer price index tracks the cost of a fixed basket of goods and services over time. The inflation rate is the percentage change in that index between two dates.

inflation rate = (index now ÷ index before − 1) × 100The same formula works for the price of a single item or a basket you track yourself.

Worked example: an index that moves from 250.0 to 262.5 has risen 262.5 ÷ 250 − 1 = 0.05, so inflation was 5.00%. For several years, take the root. If a regular purchase rose from 80 to 92 over 4 years, the total rise is 15%, and the yearly average is (92 ÷ 80)^1/4 − 1 = 3.56% a year.

The same idea applies to pay. If your salary rises 3% in a year when prices rise 4%, your buying power changes by 1.03 ÷ 1.04 − 1 = −0.96%. A salary of 40,000 becomes 41,200, but the same basket now costs 4% more, so the raise is worth about 39,615 in last year's prices. A raise only improves your position if it is larger than inflation.

An official rate describes an average household basket. Your own experience can differ if you spend more on categories that are rising faster, such as rent, fuel or food.

Projecting a future price

future price = price now × (1 + inflation)^years

Worked example: a coffee costs 4.00 today. At 3% inflation it costs 4.00 × 1.03¹⁰ = 5.38 in ten years and 4.00 × 1.03²⁰ = 7.22 in twenty. A basket that costs 100 now would cost 134.39 after ten years.

Prices compound just like interest does. A quick estimate comes from the Rule of 72: at 3% inflation prices double in about 72 ÷ 3 = 24 years (exact 23.45). The Rule of 72 guide explains the shortcut.

What 100 buys after 10, 20 and 30 years

To find what a fixed sum will buy in today's money, divide by the price growth factor: value in today's money = amount ÷ (1 + inflation)^years.

Worked example: 10,000 held as cash for 20 years at 3% inflation is worth 10,000 ÷ 1.03²⁰ = 5,536.76 in today's terms. That is a loss of about 44.6% of its purchasing power, with no change in the face amount.

The same logic applies to future promises. A payment of 50,000 due in 15 years, at 3% inflation, is worth about 50,000 ÷ 1.03¹⁵ = 32,093.10 in today's money.

What to do with the numbers

• Set goals in today's money, then inflate them. A goal of 20,000 in five years at 3% inflation really needs 20,000 × 1.03⁵ = 23,185.48 to buy the same things.
• Compare interest to inflation. A balance growing at 2% while prices rise 3% is losing ground in real terms. The next article, real vs nominal interest rates, shows how to adjust for this.
• Compare raises and returns with inflation. A rise or a return below the inflation rate is a cut in real terms, even though the number looks higher.
• Be careful with long projections. A constant rate is a simplification; actual inflation changes from year to year and differs between countries.

To discount a future amount back to today, use the present value calculator. To measure how much a price has changed between two dates, the percent increase calculator does the arithmetic.

This article is general education, not financial advice. The inflation rates used are illustrations, not forecasts or statements about any country's actual rate.