Purchasing Power

Purchasing power describes how much goods and services a unit of currency can buy. When prices rise (inflation), purchasing power falls; when prices fall (deflation), purchasing power rises. Maintaining purchasing power is a central goal of economic policy because it affects living standards, investment returns, and the broader health of an economy.

What purchasing power means in everyday and financial terms

• Consumer view: The amount of stuff you can buy with a dollar, euro, etc. If the price of common goods increases, the same income or savings buys less.
• Investment view: In brokerage accounts, “buying power” can also mean the dollar amount of credit available based on marginable securities.

How inflation erodes purchasing power

Inflation is a sustained rise in the general price level. As prices climb, each unit of currency buys fewer goods and services. For example, if an item costs $2 and later costs $4, the money’s purchasing power for that item has halved. Persistent inflation reduces real incomes and can erode savings and retirement nest eggs if returns don’t keep pace.

Fast fact: The U.S. experienced very high inflation in the 1970s and early 1980s, peaking near 14% in some years, which significantly diminished purchasing power.

Measuring purchasing power

• Consumer Price Index (CPI): A common gauge of purchasing power in the U.S., CPI tracks changes in a weighted basket of consumer goods and services (e.g., food, transportation, medical care). Changes in CPI are used to estimate inflation and shifts in the cost of living.
• Purchasing Power Parity (PPP): An international comparison concept estimating what exchange rates should be so that the same basket of goods costs the same in two countries. PPP is used to compare living standards and relative prices across countries.

Causes of purchasing power loss or gain

Losses:
* Inflation (demand-driven, cost-push, or monetary factors)
* Policy missteps or unstable fiscal/monetary environments
* Disasters, wars, or shocks that disrupt supply
Gains:
* Deflation (falling prices), though prolonged deflation can harm economies
* Technological progress that lowers production costs and consumer prices

Historical examples

• Germany after World War I: Reparations, money printing, and economic disruption led to hyperinflation in the 1920s, rendering the currency nearly worthless and collapsing purchasing power.
• 2008 financial crisis: Central banks (notably the U.S. Federal Reserve and the European Central Bank) used near-zero interest rates and quantitative easing (large-scale asset purchases) to stabilize financial markets and support economies. These actions aimed to prevent deflation and protect purchasing power, illustrating how monetary policy can be used to manage price stability.

Governments and central banks generally target moderate inflation (commonly around 2%) to balance growth and price stability.

Protecting purchasing power

Investors and savers can use several strategies to reduce purchasing power risk:
* Inflation-linked securities: Treasury Inflation-Protected Securities (TIPS) and similar bonds adjust principal or payments with inflation.
* Real assets: Commodities, real estate, and other tangible assets often retain value during inflationary periods.
* Equities: Stocks can offer growth that, over the long term, may outpace inflation, though they carry market risk.
* Diversification: Combining asset types and geographic exposure can reduce vulnerability to localized inflation or currency weakness.

Avoid overexposure to fixed-rate instruments (long-term bonds, fixed annuities, CDs) if you lack inflation protection, because their real returns can be eroded by rising prices.

Special considerations for retirees

Retirees living on fixed incomes are particularly vulnerable to purchasing power loss. Ensuring that a portion of retirement assets can generate returns that at least match inflation—or that income streams are inflation-adjusted—helps preserve standard of living over time.

Key takeaways

• Purchasing power is the real value of money measured by how much it can buy.
• Inflation reduces purchasing power; deflation increases it but can harm economic activity if prolonged.
• CPI and PPP are principal tools for assessing purchasing power domestically and internationally.
• Protecting purchasing power involves using inflation-protected securities, real assets, equities, and diversified strategies—especially important for retirees and holders of fixed-income assets.

Bottom line

Purchasing power affects everyday living standards and long-term financial planning. Monitoring inflation indicators and choosing investments that have the potential to outpace inflation are essential steps to preserve real wealth over time.