Growth of Assets During Inflation: Understanding Real and Nominal Values
Inflation can have a significant impact on the value of various assets. Not all assets react to inflation in the same way. Understanding how different types of assets behave during inflation periods can help investors make informed decisions to protect their wealth. This article delves into what assets grow with inflation and explains the difference between nominal and real values.
The Impact of Inflation on Assets
During times of inflation, anything that does not lose value within its normal lifespan tends to maintain its purchasing power. Real estate, your home, gold, and certain types of stocks are examples of such assets.
For instance, during the late 1970s in the United States, the inflation rate was around 20% annually. This was the highest rate in the knowledge of many individuals, including the author and their father. This period led to a cycle of rapid spending to avoid higher prices on goods and services, which in turn pushed prices even higher.
Nominal Value and Real Value
It's important to differentiate between nominal value and real value to understand the impact of inflation on assets. The nominal value of an asset is its value in current prices, without considering the effects of inflation. In contrast, the real value reflects the purchasing power of the asset after adjusting for inflation.
For example, if the interest rate is 5% and you have $100, it grows to $105 after one year. However, if the price level rises by 7%, the real value of your $105 drops to $98, as you can now buy less than you could before the price increase.
This illustration highlights the importance of considering both nominal returns and real returns when evaluating investments. If the inflation rate is higher than the interest rate, the real value of your assets will decrease. Conversely, a moderate level of inflation can be beneficial for the economy, as long as it is less than the prevailing interest rate.
Role of Monetary Authorities
Monetary authorities, such as the central bank of a country, play a crucial role in regulating interest rates to ensure that the economic environment remains stable. By setting interest rates at levels that are higher than the inflation rate, they can help preserve the real value of assets.
The primary objective of monetary authorities is often to maintain price stability and promote economic growth. To achieve this, they use various tools, such as open market operations, reserve requirements, and policy statements, to influence the money supply and interest rates.
Key Takeaways
During inflationary periods, assets that do not lose value tend to maintain their purchasing power, making them suitable investments. However, it's crucial to consider both nominal and real values to understand the true impact of inflation on your assets. Additionally, the role of monetary authorities in regulating interest rates is essential for maintaining economic stability and protecting the real value of your investments.
By staying informed about inflation rates, interest rates, and the behavior of different asset classes, you can make more informed investment decisions that protect your wealth and ensure its value is maintained over time.