Macroeconomics

[brandy.spencer]

How does inflation affect the purchasing power of someone on a fixed income?  When considering retirement, why might a pension plan indexed to the CPI be preferable?   

[Celeste]

On a fixed income, or salary, inflation makes purchasing commodities more difficult simply due to cost increases. For example, if the cost of groceries increased by 2 to 4%, and the amount spent per month is $1,000, this suggests that in a month, a family could be spending $40 more than they would normally. Multiplying this by 12, that's a total of $480. Anyone paying for insurance, mortgage, or energy bills will have a hard time coping with these changes if they happen year to year. Inflation will happen, but it has to be a reasonable increase because otherwise their current job will not be enough for living expenses.

A retirement plan indexed to the CPI is best because if hyperinflation occurs, their savings will reflect the consumer price index. This will not harm them if they were planning on using a fixed sum every month, for example.