Inflation is a general rise in prices over time. Its mirror image is a fall in the value of each unit of money: the same notes buy less than they used to. A savings balance can grow in number and still shrink in what it can actually purchase, and the gap between those two views is the whole point.
Nominal vs real value
- Nominal is the number on the statement. $10,000 is $10,000.
- Real is what that money can buy, measured against prices. If prices rise, the real value falls even when the nominal amount is unchanged.
The formula for buying power is real value = nominal ÷ (1 + i)n, where i is the annual inflation rate as a decimal and n is the number of years.
Worked example: $10,000 at 3% inflation
- Nominal amount: $10,000. Inflation: i = 0.03. Years: n = 10.
- Price level after 10 years = 1.0310 ≈ 1.3439.
- Real value = 10,000 ÷ 1.3439 ≈ $7,440.94.
- So $10,000 in ten years buys what about $7,441 buys today — a loss of roughly 26% of purchasing power.
Buying power over time
| Years | At 2% inflation | At 3% inflation | At 5% inflation |
|---|---|---|---|
| 0 | $10,000 | $10,000 | $10,000 |
| 5 | $9,057 | $8,626 | $7,835 |
| 10 | $8,203 | $7,441 | $6,139 |
| 20 | $6,730 | $5,537 | $3,769 |
The figures are the real value of $10,000 held as cash, with no interest. Each row shows how much of today's goods that sum would still buy. Higher inflation and longer time both cut deeper, and the effect is not linear: it accelerates.
Why cash under the mattress loses
Money that earns nothing falls in real terms at the inflation rate. Money in an account earning a rate below inflation also loses, just more slowly. Only a return above inflation preserves or grows purchasing power. This is why "keeping up with inflation" is a common goal: it means the real value stays flat.
Real returns and the Fisher idea
To compare a return with inflation, subtract approximately: real return ≈ nominal return − inflation. An account paying 4% while inflation runs at 3% grows purchasing power by roughly 1% a year. For larger rates the exact relationship is real = (1 + nominal) ÷ (1 + inflation) − 1, which is slightly lower than the subtraction. The shortcut is fine for a quick estimate, the exact form for anything precise.
Wages, prices and the mismatch
Inflation is an average across a basket of goods. Your personal inflation can differ: if rent and food, the two biggest items for many households, rise faster than the average, you feel worse off even when the headline rate looks modest. A pay rise that matches average inflation may not match your own costs. Comparing your wage growth with the price rises you actually face is more useful than tracking the headline number alone.
What this does and does not tell you
Inflation calculations are estimates built on assumed rates. Nobody knows future inflation, so any projection is an illustration of a scenario, not a forecast or a promise. This material is educational rather than advice; decisions about saving and investing depend on your circumstances and, for many people, a qualified professional.
Use our inflation calculator to run the numbers forward or backward at any rate, and see how prices and buying power change. For related topics, read how much to save each month and what you actually pay on a loan.