Chapter 10: Problem 307

Elaborate on the following statement: "Inflation also casts its evil eye upon savers". Give an example to make your point clear.

Short Answer

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Inflation refers to the rising prices of goods and services, causing the purchasing power of money to fall. Savers are negatively impacted when the inflation rate is higher than the interest earned on their savings, resulting in a decrease in their purchasing power. For example, if a saver has $1000 in a bank account with a 2% interest rate, and the inflation rate is 3%, after one year, their money grows to $1020, but the purchasing power has decreased to roughly $1030 due to inflation. Thus, inflation effectively acts as a 'hidden tax' on savers by eroding the value of their savings.

Step by step solution

Defining Inflation

Inflation refers to the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. To put it simply, inflation occurs when the money in our hands and banks, buys less than what it used to, typically measured as an annual percentage increase.

Understanding the Impact on Savers

When inflation is present in an economy, the value of money decreases over time. This implies that, for savers, the buying power of the money saved will decrease as the prices of goods and services in an economy increase. Consequently, if the inflation rate is higher than the interest gained on savings, savers will lose purchasing power, which negatively impacts them.

Giving an Example

To make it clearer, let's present a simple example: Assume a saver has \$1000 in a bank account that offers a 2% annual interest rate, and the inflation rate is 3% per year. After one year, the saver's money grows to \$1020 (due to the 2% interest), but the actual purchasing power of that money has decreased. To buy goods and services that cost \$1000 a year ago, one would now need roughly \$1030 because of the 3% inflation rate. As a result, instead of gaining, the saver actually has less purchasing power at the end of the year - the 'evil eye of inflation' causing the value of their savings to decline.

Concluding

In conclusion, inflation acts as a 'hidden tax' on savers by eroding the purchasing power of money saved, especially when the interest earned on savings is less than the rate of inflation. It's for this reason that the statement uses the term 'evil eye' referring to the negative impact of inflation on savers.

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