How Inflation Affects Borrowing, Saving, and Investing?
Interest is the price of money. During times of high inflation, interest rates on new loans for cars, homes, and credit cards rise. Even though nominal interest rates for savers rise as well, the increases do not provide “real” gains if the inflation rate is higher than the interest rate on savings accounts or certificates of deposit.
Smart investors recognize that the degree of inflation risk is higher for long-term lending (5 or 20 years, for example) than for short-term lending (such as a year) because the likelihood of error when estimating inflation increases when lots of time is involved. Therefore, long-term interest rates are generally higher than short-term interest rates.
Similarly, stock market investors are negatively affected when inflation causes businesses to pay more when they borrow, thereby reducing their profits, and depressing stock prices. When inflation is at 5 percent annually, a rupee of profit that a company will earn a year from now will be worth only 95 paisa in today’s prices. If instead inflation was only 2 percent, that rupee would be worth 98 paisa today. Such differences add up over many years. Throughout your financial life, you will want to factor the impact of inflation into your financial decisions in an effort to avoid its negative effects.