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Low inflation benefits savers

August 30, 2010

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Savings account interest rates may be frustratingly low, but savers do have one thing going for them right now--a relatively low current rate of inflation. Simply put, low inflation favor savers over spenders. Although inflation can certainly be expected to increase above its current low levels, savers may find benefits to shopping for higher savings account rates.

How does inflation affect savings?

Low inflation heightens the value of savings. This effect is more easily understood by first looking at the converse situation: high inflation.

In a high-inflation environment, the cost of goods rises rapidly. Rapidly rising prices--especially those of big-ticket items such as houses or cars, which typically require some saving--mean that consumers will try to make purchases sooner rather than later, before they become even more expensive.

Witness the recent housing boom. As housing prices rose quickly, many prospective home buyers jumped into the market before they were priced out--and, in many instances, before they saved enough for a conventional down payment or costs associated with home ownership.

Low inflation and the savings mindset

High inflation, then, creates a disincentive to save, and low inflation is a factor that encourages saving.

The first decade of the 21st century was a period of relatively low inflation, as measured by the Consumer Price Index (CPI). (The CPI reflects inflation across many categories of consumer goods but excludes home purchase prices.) From the beginning of 2000 through the end of 2009, the CPI increased at an annualized rate of 2.55 percent. In contrast, for the 50-year period through the end of 2009, the CPI increased at an annualized rate of 4.08 percent.

With compounding, this seemingly small difference means that consumer prices doubled only about half as quickly during 2000-2009 as during the entire period of 1959-2009--a low inflation rate indeed. In this kind of environment, there's a low penalty for individual consumers to delay purchasing goods.

Finding savings account rates above inflation

Many consumers saved little during the last decade's low inflation, instead directing their funds toward home purchases, but we're still in a low-inflation period, with the CPI at just over 2 percent for the past year.

Of course, for savers, the environment was even better around the middle of last year, when prices were actually dropping. For the year ending July 2009, the CPI declined by 1.98 percent. It didn't matter too much if savings account rates were only averaging about 0.22 precent back then--they were still running more than two percentage points above inflation. Since then, inflation has returned to positive territory, but savings account rates have remained stagnant. Low inflation is good for savers, but only if they can find returns greater than inflation.

How can you take advantage of this low-inflation period while making sure your savings are being put to good use? By actively shopping for the best savings account rates, you should be able to find many options that earn more than the rate of inflation.

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