What is purchasing power?
What money can actually buy — the quantity inflation erodes even while the number in the account grows.
Purchasing power is what money actually buys - the quantity of goods, services or life a given sum commands. It is not the number printed on a balance or a payslip; it is what that number converts into at the till. The figure on the account can climb every year while purchasing power falls, because inflation quietly reduces how much each unit of currency buys. That gap between the number and what it’s worth is the whole story of purchasing power.
The arithmetic of erosion
Take €10,000 owed to you in 30 years’ time. At 2% annual inflation, that sum buys only the equivalent of €5,520.71 in today’s terms. The euros haven’t vanished - you’ll still receive €10,000 - but roughly half their buying power has. Over shorter spans the effect is gentler but still real: €26,533 received in 20 years buys about €17,856 of today’s goods at the same 2% rate. The longer the wait, the more purchasing power a fixed future sum loses, because erosion compounds year on year just as interest does.
Why ‘in real terms’ matters
A nominal figure is the raw number: the interest rate quoted, the salary printed, the balance shown. A real figure adjusts that number for inflation, expressing it in constant purchasing power so it can be compared honestly across time. The two can tell opposite stories. A 5% nominal return against 2% inflation leaves a real return of 2.94% - genuine growth in purchasing power. At 10% nominal against 8% inflation, the real return falls to 1.85%, well below the 2% a quick subtraction would suggest. And at 2% nominal against 5% inflation, the real return turns negative at -2.86%: the balance still grows, but its purchasing power shrinks every year.
Questions people ask
What does "in real terms" mean?
"In real terms" means adjusted for inflation: measured in constant buying power rather than in raw euros. A balance can grow in nominal terms while shrinking in real terms, so 2% interest earned against 5% inflation still leaves you with a real loss of about 2.86% a year.