Inflation

If prices rise three percent over a year, the same $100 covers what $97 covered twelve months earlier. Nothing was taken out of the account; the money simply reaches less far. That is the whole idea, and it is measured by tracking the cost of a fixed basket of goods and services over time.

It reaches share prices along several routes at once, which is why its effect is argued over rather than settled. Companies face higher input costs, and how much of that they can pass on to customers varies enormously by business. Households have less left for things they can postpone. And central banks respond to inflation by moving interest rates, which changes what profits arriving years from now are worth today.

It is also why long-run investment returns get quoted in two forms. A nominal return is the raw percentage. A real return subtracts inflation and describes what the money gained in purchasing power. Comparing a nominal figure from one era against a real one from another produces a conclusion about nothing at all.