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Cash under the mattress halves
Cash loses ground
Inflation has run through history and is unlikely to go away, and central banks in most developed countries target a low but stable rate of it. That steady rate means money under a mattress buys less every year, and at 3% it loses about half its purchasing power across 20 years.
Short-term government debt can roughly keep pace by paying a little interest, though periods of high inflation can cut even that in real value.
Cash as a risk
Holding cash is a type of risk in its own way, because cash has no expected return and, in real terms, a negative one. Stocks have far outpaced inflation throughout history, and low-cost index funds capture that growth without the drag of high fees.
Why do central banks aim for some inflation?
New Zealand adopted the first explicit inflation target in 1990, and many central banks followed, including those of Canada, the United Kingdom, and later the Federal Reserve. A target near 2 percent leaves room above zero because falling prices can discourage spending and make debts heavier. Wages also rarely fall in nominal terms, so rising prices let employers adjust real pay. A little inflation also gives central banks space to cut interest rates before they hit zero.
Why can government debt lose value in high inflation?
Short-term government debt pays interest that is set in advance, while inflation can climb faster than rates adjust. During the 1970s, US Treasury bills often paid less than the inflation rate, which gave holders a negative return after inflation. In 1974, for example, US inflation averaged about 11 percent while Treasury bills paid around 8 percent.
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