You might recall the iconic scene from the first Austin Powers movie where Dr. Evil, after being frozen since 1967, returns in 1997 to enact his nefarious plans. His grand scheme? To hold the world ransom for a cool $1 million. In his mind, it was an astronomical sum, a figure that would surely bring nations to their knees. But as Dr. Evil soon discovered, times had changed, and his understanding of money hadn’t quite kept up.
As University of Chicago economist Damon Jones points out, Dr. Evil’s downfall wasn’t his evil genius, but his economic illiteracy – specifically, his failure to account for inflation. “There’s the Dr. Evil guy… And he gets frozen in time,” Jones explains, setting the stage for the comedic economic blunder. Upon his return, Dr. Evil confidently demands $1 million, believing it to be an insurmountable fortune. The reaction he receives is less than intimidating. “And he’s like, ‘This is so much money. They’ll never come up with this money.’ And they’re like, ‘That’s it? That’s all you want?’”
Dr. Evil’s bewildered expression perfectly encapsulates his economic misjudgment. He hadn’t adjusted for inflation, a critical factor in understanding the real value of money over time.
Inflation and the CPI: Dr. Evil’s Economic Kryptonite
So, what exactly is inflation, and how did it trip up Dr. Evil? In simple terms, inflation is the rate at which the general level of prices for goods and services is rising, and consequently, the purchasing power of currency is falling. The same dollar buys less over time.
To measure this change, economists use tools like the Consumer Price Index, or CPI. As Jones explains, “So $1 million purchased a lot more in his time than when he was unfrozen. So he should have checked the CPI before going into that negotiation.” The CPI acts as a yardstick, tracking the average change in prices paid by urban consumers for a basket of consumer goods and services.
Using the CPI inflation calculator, we can see the stark reality of Dr. Evil’s mistake. A million dollars in 1967 had significantly more buying power than a million dollars in 1997. In fact, a dollar in 1967 was worth approximately five times more than a dollar in 1997. Dr. Evil’s million dollars, while seemingly substantial to him, was a pittance in the late 90s economy.
Real vs. Nominal Value: Beyond the Face Value
This brings us to the crucial concept of “real” versus “nominal” value. Economists use these terms to differentiate between the face value of money (nominal) and its purchasing power adjusted for inflation (real). Treasury Secretary Janet Yellen touched upon this in a “Marketplace” interview, highlighting the stagnation of real wages for many Americans.
“The typical American who does not have a four-year college degree has barely seen any increase in their real or inflation-adjusted wages, really, in 40 or 50 years,” Yellen stated. While nominal wages might have increased, the real value, what people can actually buy with their earnings, hasn’t significantly improved for this demographic.
UBS economist Alan Detmeister further clarifies this point: “They’re able to buy basically the same thing they were 40 or 50 years ago, but they aren’t able to buy a lot more than they were 40 or 50 years ago.” People may be earning more in dollar terms, but inflation has eroded the increase in their purchasing power, leaving them in a similar economic position in real terms.
Janet Yellen speaking about inflation
Economists often use the term “real” to denote amounts adjusted for inflation. Jones explains, “I think about real as measuring the quantity of things and activities that are taking place, to kind of remove the part that’s just due to prices rising.” For example, when we hear about “real GDP growth,” it signifies actual economic expansion, factoring out the impact of price increases.
Don’t Be Like Dr. Evil: Adjust for Inflation in Your Own Life
While Dr. Evil’s economic blunder is humorous, it carries a valuable lesson. Understanding inflation is not just an academic exercise; it’s crucial for making informed financial decisions in our daily lives.
Detmeister astutely observes, “People think in nominal terms. So, their wages moving up is good. Prices moving up is bad.” However, he emphasizes the importance of considering the relationship between wage increases and price increases. The key question is: “How much more does this wage increase allow me to buy?”
When negotiating a raise or evaluating your financial situation, it’s essential to think beyond nominal figures and consider real value. Just as Dr. Evil should have consulted the CPI before making his demands, we should all be mindful of inflation’s impact on our purchasing power. By understanding and adjusting for inflation, we can avoid making our own “Dr. Evil” level economic miscalculations and ensure we’re not selling ourselves short in today’s world.
