“I live my life in dollars today. I cannot to burger king and offer them $3.50 for a whopper because the $4.50 price is nominal dollars and I want to pay in real dollars.”
Real dollars make sense when making intertemporal comparisons. Today, $4.50 nominal dollars are exactly the same thing as $4.50 real (2007) dollars. Therefore, it makes no sense to distinguish one from the other if all I care about is the present.
OTOH, suppose that back in 1980 Burger King offered to give you a free burger a day for life, but in reality they gave you $0.99 coupons. If a burger cost $0.99 in 1980, that’s fine then, but what would happen as time passes by and burgers become more “expensive” in nominal terms? By 2007 the $0.99 coupon would cover less than a quarter of the cost of a $4.50 burger. Won’t you feel ripped off if the original offer had been a free burger for life?
To compare 1980 to 2007 we need real, or constant, dollars. Otherwise, we are comparing apples to oranges. If inflation is, say, 3% annual, after five years that’s 15.9% (compounded). Therefore, if a house was $900K in 2005, and still is $900K in 2010, then we say that the house in 2010 is actually 16% cheaper in real terms, even if the nominal price is the same.
Why? Because $900K can buy 15% less burgers (or shirts, cars, movie tickets, etc) in 2010 than in 2005. As we saw in the previous bubble burst, price drops will be in both nominal and real terms, the latter being of course a larger drop.
The point to remember is that money itself is not what maters. If we doubled all prices and all wages, etc., from one day to the next, nothing would change, right? Of course not. What matters is what I can buy with that money, not the dollar amount itself.
