Money foundations · 12 min
Money, inflation and interest
Written and reviewed by Prashant Nandkishor Maheshwari (editorial review, 2026-10-18). Not yet checked by an independent subject specialist. How we review.
What you will learn
Explain what money does, why prices rise over time, and what an interest rate really pays you or costs you.
Why it matters
Almost every money decision, from saving to borrowing, is a decision about how today's money compares with tomorrow's. Inflation and interest are the two ideas that connect them.
The ideas
Levels are a learning preference, not a credential. Switch any time.
Novice level
Money does three jobs: it is a way to pay for things, a way to measure value (prices), and a way to carry value into the future. It only does the third job well when it keeps its buying power.
Inflation means prices in general rise over time, so the same amount of money buys a little less each year. If your savings grow more slowly than prices, you can buy less with them later, even though the number looks bigger.
Interest is the price of using someone else's money. When you save, the bank pays you interest. When you borrow, you pay the lender interest. The same idea, seen from two sides.
Basic level
The interest rate is usually quoted per year. The real rate is roughly the interest rate minus inflation. The exact calculation is (1 + interest) divided by (1 + inflation), minus 1.
Nominal means the number printed on your statement. Real means what it can actually buy. Always ask which one a claim is talking about.
Advanced level
Compare the inflation measure you are using (headline, core, a household-specific basket). A household's own inflation can differ from the national index because spending mixes differ.
Expert level
The Fisher relation links nominal rate, real rate and expected inflation. Real returns are ex-post unless inflation is known; planning should use ranges, not single numbers.
Professional level
Index-linked instruments, deflators and the choice of price index matter in contracts and financial reporting. Follow the standard or contract definition, not a generic one.
Key terms
- Inflation
- A general rise in prices over time.
- Nominal rate
- The stated rate before adjusting for inflation.
- Real rate
- The rate after adjusting for inflation: what your money can actually buy.
- Principal
- The original amount saved or borrowed.
Worked example
Illustration only, not a prediction. A basket of goods costs ₹100 today. With 6% inflation it costs 106 next year. A savings account paying 3.5% turns ₹100 into 103.5. Real change = 103.5 / 106 - 1 = -2.4%. The balance went up, yet it buys about 2.4% less.
Try it yourself
Pick three things you buy often. Write down what you paid for each a year ago, if you remember, and what you pay now. Which rose most? Does your income or savings rate keep up with that item?
Nothing you write here is collected. Use paper or the workbook.
Try it with numbers: Inflation and future cost calculator.
Check yourself
A common misunderstanding
'A bigger number means I am better off.' Only if prices have not risen faster than the number.
Local context
Inflation and interest rates differ widely by country and over time. Look up current figures from your central bank or national statistics office before using them in a plan.
References and review
- Your country's central bank and statistics office (current inflation and policy-rate data).
- Mishkin, F. S., The Economics of Money, Banking and Financial Markets (Pearson), chapters on money and interest rates.
Author and editorial reviewer: Prashant Nandkishor Maheshwari, 2026-10-18. Independent specialist review is pending. Spotted a mistake? Tell us.
Suggested next step
Continue with 'Compounding and the time value of money'.
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