What happens to the REAL value of currency (like money sitting in a shoe box) during periods of high inflation?
The correct answer and explanation is:
Answer:
During periods of high inflation, the real value of currency—such as money sitting idle in a shoe box—decreases significantly. This means that the purchasing power of that money declines, and you can buy fewer goods and services with the same nominal amount of currency over time.
Explanation:
Inflation is the rate at which the general level of prices for goods and services rises, leading to a decrease in the purchasing power of money. When inflation is high, prices increase rapidly. If you keep money as cash—like in a shoe box—it does not earn interest or grow in value. Instead, it loses real value because the amount of goods or services you can buy with it falls.
To understand this, it’s important to distinguish between nominal value and real value:
- Nominal value is the face value of money—the number on the bill or coin.
- Real value is what that money can actually purchase in terms of goods and services, adjusted for inflation.
For example, if you have 1,000 Kenyan shillings in a shoe box and inflation is running at 20% per year, after one year, the prices of goods and services will, on average, be 20% higher. Your 1,000 shillings will buy 20% less than it did before, so its real value has dropped.
High inflation erodes the value of money because the cost of living rises. People holding cash lose wealth in real terms unless their income or investments adjust for inflation. This is why during inflationary times, individuals and businesses often seek to convert cash into assets like real estate, stocks, or commodities that tend to keep pace with or outpace inflation.
In summary, money sitting idle during periods of high inflation loses purchasing power, reducing its real value. To protect against this, people look for ways to invest or spend money quickly before inflation erodes its worth.