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My take on this is that Real money
is at a specific date, whereas Nominal money is at whatever date it is charged or paid for.
For example interest rates that are
charged or forecast to apply at a specific date, are Nominal rates. When we forecast future rates and discount them for
forecast inflation (ie future reduction in buying power) we are using Real returns. An example from personal investment, If my
investments earn 10% but inflation (reduction in my future buying power) is 2%, then my Real forecast return is (10% - 2% =)
8%.
A consequence of this is that
where an estimate is defined as being the cost at a specific date, then it is assumed that all nominal or past rates used in
the estimate are escalated to the estimate base date using escalation and foreign exchange indices. We can then reliably
forecast future costs using the cost at a defined base date.
In practice companies maintain cost
data in a format that allows for them to include a Nominal base rate that allows escalation to a current day. In the
current low inflation environment, the practice of effectively ignoring escalation by defaulting to a consumer price index is
risky for construction projects. We only have to look at the correlation between the price of iron ore and
fabricated steel, the oil price, or the variances in FX rates to see how construction costs can be
severely impacted.
Regard's
Nolan
Bear,
B Eng, MBA(tech), DipEd, FIEAust,
EngExec, CPEng (Cost, L&M), NER
Past National Chair, Australian
Cost Engineering Society; Past President, Australian Section AACE International;
Industry Fellow, Swinburne
University of Technology
Email: nolanbear@gmail.com; Website:
www.costengineer.org.au
Mob: +61 (0)425 801 813
Skype: noel.bear; Swinburne 03 9214 5319
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