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How to quantify the relevant value change?

Why doesn't the nominal value of financial assets change when inflation occurs?

  • I cannot understand this: "The nominal value of financial assets doesn't change when inflation occurs, instead, the value measured by buying power decreases." Real assets' nominal value increases when inflation occurs, but the value measured by buying power doesn't change.

  • Answer:

    It is mainly a semantic thing. Many financial assets, like bonds for example, have face values or nominal values. (They are the same thing.) After a bond is issued, it will usually have a different real or market value to reflect conditions in the market. One important condition is the level of inflation. The nominal value is set when a bond (e.g. a financial asset) is issued. (Stocks don't have nominal values, btw.) Bonds usually have a face value or nominal value of $1000.  After they are issued, as inflation occurs (or doesn't) the nominal value of the bond continues to be $1000. That is the base that continues to be used to determine the periodic interest payment AND it is the amount the borrowing company repays the investor at maturity. If, for example, a bond interest rate was set at 6% when it was originally issued, then every year investors receive a $60 interest payment, regardless of what inflation is. And at maturity the company repays the investor the $1000 that s/he originally paid for the bond (assuming our investor bought the bond at face value when it was issued. However, the bond's market price, that is, the price our investor could sell it for, changes over time as inflation occurs even though its nominal value remains fixed at $1000. If inflation increases after the bond was issued, interest rates in the market will tend to go up. The market rate was 6% when our example bond was issued. If inflation grew later on, interest rates for bonds similar to our example bond would increase. If they increased to 10%, then the price of the bond in the market would fall such that the flows from the bond, which continue to consist of an annual interest payment of $60 plus a final payment at maturity of $1000, were equivalent to the 10% yield that was now available in the market.

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http://www.econ.yale.edu/~shiller/online/uf-usa4.html is a means that Chile, Colombia, Ecuador, Mexico, and Uruguay have tried in an attempt to correct for inequities that may occur during high inflation.  The attempt seems to be intended to work on the opposite effect, name that with high inflation, loans, mortgages and bonds are easier to repay but loose their buying power. Discussions of how the technique worked are on the web. More recent articles suggest the issues that would emerge or be resolved with a crypto-currency. http://www.nytimes.com/2014/03/02/business/in-search-of-a-stable-electronic-currency.html?_r=0 and its rebuttal http://reszatonline.wordpress.com/2014/03/06/inflation-indexing-and-bitcoin-rhetoric/ http://www.nytimes.com/2014/03/02/business/in-search-of-a-stable-electronic-currency.html?_r=0 The bottom line:  The price of a free economy is variability as various instruments of value adjust to changes in the economic environment.  Governments have, in the past, attempted to fix prices, generally with awful unintended consequences.  The adoption of  Indexed Units of Account does not seem to have been a huge success.

John Bailey

Let's take baby sox for example. They don't change, the kid outgrows them, the product remains the same but after a certain point in time does not fit the baby for whom it was bought, does this mean the product ceases to exist or undergoes a molecular transformation to adjust to the size of baby's feet now? No. Same with the nominal of the stock, only difference being the valuation can move up or down based on the market conditions. You need an underlying factor to base your valuation on, a piece of land, a canvas, a share, how their valuation moves through time is how they are validated and deemed necessary at a necessary point as needed. So you're question isn't entirely correct, valuations are adjusted to inflation, which is why when they talk about Star Wars franchise being the most profitable franchise, they include a comment saying numbers adjusted to inflation.

Vamsi Gopal

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