Suppose that you are 70 years old, with $300,000 in savings but no income. How much can you afford to spend each year? If you spend too much and live a long time, you will run out of money. If you spend too little and die unexpectedly early, you will leave behind a large estate, but you will have cheated yourself out of a better quality of life.       Inflation and the Real Interest Rate: One thing that you would have to worry about with your $300,000 in savings is having the value of your money eaten away by inflation. If the average cost of the goods that you buy rises by 5 percent per year, then the purchasing power of your savings falls by that same 5 percent per year.An increase in the average cost of goods that people buy is called inflation. There are many ways to measure inflation, depending on how you assign weights to different goods. The most well-known measure of inflation in the United States is called the Consumer Price Index, which uses a weighted average of the cost of food, gasoline, utilities, medical care, and other goods and services that people commonly consume.Each year, the purchasing power of our savings declines at the rate of inflation. Economists use the symbol p to stand for the rate of inflation.The interest rate that you earn on your savings usually is higher than the rate of inflation. If the inflation rate is 6 percent, then the interest rate would typically be somewhere between 8 and 10 percent. If the inflation rate is 2 percent, the interest rate typically would be somewhere between 4 and 6 percent.
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