Inflation and purchasing power
Inflation is the general and sustained rise in prices. When there is inflation, the same amount of money buys fewer things each year. That is why it is sometimes called "the invisible tax": no one charges it to you explicitly, but it takes value away from you.
Purchasing power
Purchasing power is the amount of goods and services you can buy with your money. Inflation reduces it: even if you have the same euros, they are worth less in terms of what you can acquire.
Example: with 3 % inflation, what costs €100 today will cost €103 a year from now. Your €100 today will buy, a year from now, what costs about €97 today.
How it is measured: the INE's CPI
In Spain, inflation is measured with the CPI (Consumer Price Index), published each month by the INE (National Statistics Institute). The INE tracks the price of a representative "shopping basket" (food, housing, transport, leisure…) and calculates how much it has risen compared with the previous year.
When you hear "year-on-year inflation is 3.4 %", it means that basket costs 3.4 % more than twelve months ago, according to the CPI.
The long-term effect is brutal
3 % a year seems small, but it compounds against you year after year. What costs €1,000 today, with a constant 3 % inflation:
| Years | Future cost | Purchasing power of €1,000 today |
|---|---|---|
| 5 | €1,159 | €863 |
| 10 | €1,344 | €744 |
| 20 | €1,806 | €554 |
| 30 | €2,427 | €412 |
In 30 years, money under the mattress loses more than half its buying power. Just saving is not enough: you have to defend its value.
Real return: what really matters
That is why the key figure when investing is not the plain return (the nominal one) but the real return, after subtracting inflation:
Real return ≈ nominal return − inflation
A deposit at 3 % with 3 % inflation gives you a 0 % real: you keep your buying power but don't grow. An investment at 7 % with 3 % inflation is a ~4 % real.
How to protect yourself
- Don't keep idle more money than necessary (apart from the emergency fund). Cash loses purchasing power for sure.
- Invest in assets that historically beat inflation over the long term (diversified stocks, real estate), accepting their risk.
- Remember that many incomes (rents, some salaries, pensions) are adjusted with the CPI, which helps maintain purchasing power.
The figure almost nobody adjusts: your FIRE target in today's euros
If you work out that you need €1,000,000 to retire in 25 years, beware: with 2.5 % inflation, that million will buy what about €540,000 buys today. The correct nominal target would be considerably higher. That's why serious projections work in constant euros (real return) rather than nominal: otherwise you fool yourself with big numbers that will be worth less.
Common mistakes
- Confusing falling inflation with falling prices. CPI going from 10 % to 3 % means prices rise more slowly, not that they drop.
- Treating cash in an account as "safe". It's nominally stable but loses purchasing power every year with total certainty.
- Ignoring inflation when comparing a "fixed" rent with a mortgage. A fixed mortgage payment doesn't rise; many rents are reviewed by the CPI.
Defend yourself by keeping only the emergency fund in cash and investing the rest in assets that have historically beaten inflation.
This is educational information, not investment advice.