The money illusion

When I was in high school (around 1950), an income of $5,000 a year was considered barely enough to get by on, $10,000 a Cyear was good money and $50,000 a year was great wealth.

So when college graduates who get $50,000-a-year jobs and still complain, their elders tend to be unsympathetic.  This is what the great economist John Maynard Keynes called “money illusion.”

As Kevin Drum of Mother Jones pointed out, $50,000 a year today is equivalent to $18,000 a year in 1980 and $6,000 a year in 1960 in terms of what the money can buy.

When inflation is low, as it is now, it is natural to think of it as nonexistent, but this is a mistake.  Even an inflation rate of 2 to 3 percent a year can erode income (and savings) more than you might think because of compounding.  You don’t subtract $2 to $3 from $100 every year, you subtract 2 to 3 percentage points of each year’s lower sum.  Inflation is like compound interest, except in reverse.

LINKS

Compound inflation is probably higher than you think by Kevin Drum for Mother Jones.

The wage is too damn low by Duncan Black, aka Atrios, on his Eschaton web log.

Why you should always adjust for inflation

This chart shows why no economic statistic is valid unless an adjustment is made to allow for the effects of inflation.

If you just look at income in terms of dollars, the American middle class has not done all that badly in the 21st century.

If you look at what those dollars will buy (setting aside the question of whether the CPI underestimates the true cost of living), the figures tell a different story.

For the context of the chart, click on Rising Inequality: Recovery Driven Almost Entirely by the Rich by “Gaius Publius” for the Center for Media and Democracy