Hi all, can someone clarify this for me. When if ever is inflation included in the liquidity constraint calculation for individuals or institutions.
Thanks in advance.
It isn’t. It is included in return calculation if asked to calculate on nominal basis what is almost always the case. It may be discussed as constraint if is high in risk constraint but it is not included in liquidity constraint.
Okay great thanks. To confirm, does this include specific cases where it is note that costs grow at a certain inflation (eg. in case of endowment where it is stated OPEX of underlying institution will grow at x% per some related benchmark inflation)?
Thank you.
I would say Spending needs raise with inflation if it states in the case… so for example if you are asked for liquidity needs in year 3 and case says spending needs grows with inflation then when you calculate the $ amount of money needed you should gross it up by inflation for the three years from year 1 to get th new spending needs and then times it by asset base.
Remember we include it in the Return requirement so your calculation for liquidity would be
Asset Base + Nominal Return (inflation included) = new asset base * (inflation adjusted or nominal spending rate) = Liquidity for the year
^ Inflation growth is already included in Asset base at Time T or T-1. You have double counted in liquidity calculation at Time T.