Real vs Nominal (Interest rates and GDP)
This post is for all those lucky public school teachers out there who make $28,000 a year. Have you ever wished that you could use those dollars in, for example, 1914. I'm sure you've considered it. Just think! If I had only been able to take $100 of my money and put it into Coca-Cola. I'd be rich!
I know you all realize this is just wishful fancy. However, I must burst your bubble further. Just as you cannot go back in time, you also cannot assume $28,000 of currency in 2008 translates into the same thing in 1914. We have to take into account that word that homeowners love (because it makes them wealthier), and teachers hate (because they live on fixed income) Inflation!
This is the difference between real and nominal variables in economics, real variables have been adjusted for inflation. For example, say as a teacher you make $28,000 a year. However, you do not receive pay raises and every year inflation causes the price level to increase by 5% generally. You might think you income is staying the same. But it turns out, to your dismay, that you are effectively receiving a 5% paycut every year!
In the same line of thinking. Let's say our GDP grew a nominal rate of 8% from 2007-2008. However, inflation was 6%. Adjusted for inflation, our GDP would have grown by a real rate of 2%.
It also works the same way for interest rates. Let's say you put money into a savings account at 2% interest. However, inflation is usually around 3% even in a healthy economy. You are in fact losing 1% of the value of your money by putting it into a savings account!
Therefore, you have to be wary of inflation when you are considering your financial future. You may think you are gaining something or only losing a little, when it fact it is more than you bargained for! Yet, inflation can be a good thing for some people. As I previously stated for someone who owns a home. If the rate of inflation is higher than the real interest rate, your home gains value by just sitting there!
The bottom line here is. Be Real!
8 comments:
Thanks for stopping by and nice to see you're back!
Will link you up and will be watching more when I get back home!
Cheers! CM
$28,000 today is probably like $4000 was back then. Many predict there will be an Inflation Depression on the horizon.
Check out this post on the financial situation and what caused it.
Pissed on Politics
EXCELLENT article Octavian...........what people today fail to realize is that the stock market ie the Dow Jones index when adjusted for inflation is WAY WAY below the 2000 high of of 11722 even thn when it peaked at 14,200 or whatever the nominal high was in REAL inflation adjusted terms it was STILL well below that 2000 peak of 11722 and people had lost money.
Inflation is STATED at 7% this year that is a totally bogus hedonics induced sham.........in reality inflation is closer to 15% or more than double that..........That means thatREAL interest rates with the Fed Funds rate at 2 1/4 are STRONGLY negative..........this is generally poison for paper assets like stocks, government bonds, savings accounts, Certificates of Deposit etc.......that pay far less than the rate of inflation or roughly 2% to maybe 4%.............hard assets like gold, oil, silver houses, grains, etc that generally rise with or faster than inflatiion as a whole are usually good investments during times of inflation.
Notice i said USUALLY.........housing usually does rise during times when Real interest rates are strongly negative......the reason they are not rising now however is because of the excessive forclosures flooding the market and bringing down the value of housing...........AND that is precisely why i think the Fed is making a huge mistake sacrificing the dollar by lowering interest rates excessively and bailing out the wall street firms rather than the working class who are losing their homes and causing a vicious circle of further deflatiuon in housing values that is causing more forclosures and bank failures.
Also, i meant to comment a few days ago that i was glad you ALSO noticed how foolish and riddiculous McCrazy looked when he said he wished interest rates were zero.............when interest rates are zero the economy is in a Depression much like we were in the 1930's or like Japan was for the last 15 years.
McCrazy is too clueless to realize that zero percent interest rates are the sign of a deathly sick economy NOT a healthy one.
One last thing, not trying to be nosy or anything, just curious though do you attend UNC Chapel Hill and are you a business major?
My cousin went there.
Thanks for all the comments! I'm going to have to look more into hedonics. And for you mike, yes I do go to UNC-Chapel Hill. However, I am an economics major.
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