What is inflation and how does it affect savings?

• A. Inflation is wage growth that outpaces prices.
• B. Inflation is the interest earned on savings.
• C. General rise in prices reducing purchasing power; savings may lose real value if interest rates do not keep up.
• D. Inflation is a decrease in prices.

Answer: (C)

Inflation is the general rise in prices over time, which reduces the amount your money can buy. When you save, you want the growth in your savings to keep up with or exceed this rise in prices. The real value of your savings depends on the difference between what you earn in interest and the rate of inflation, measured as real return = nominal return minus inflation. If your savings rate is lower than inflation, the purchasing power of your money falls even though the balance grows. If the interest on your savings outpaces inflation, your saved money preserves or increases its purchasing power. For example, if prices rise 4% and your savings earn 2%, the real value of your savings drops. If your savings earn 5% while inflation is 4%, you gain in purchasing power. Inflation isn’t wage growth or the interest itself—it's about the overall price level and how that affects what your money can buy.