What is Inflation?
Due to the events affecting the entire world and economy over the last few years the term inflation has been used on the internet and mainstream media consistently but what is inflation? In this blog piece we will explain what inflation actually is, how it affects us wherever we are in the world and how we can best prepare for fluctuations.
What is Inflation?
Inflation is to the rate at which the general level of prices for goods and services like food rises, removing the purchasing power of money. Essentially, inflation means that over time, your money buys less than it did before. For example, if in 2024 inflation was based at 2% per year, something that cost $100 at the start of the year ago would cost $102 at the end of the year.
Why Does Inflation Matter?
Inflation affects everybody, some a lot more seriously than others. For consumers, it means higher prices for things you need to buy every week, which can negatively affect your standard of living if the wages you’re being paid don't keep pace with inflation. For those who invest, inflation can impact the real returns on investments. Central banks monitor inflation closely because it influences economic policy decisions.
What Are The Causes Of Inflation?
Inflation can be driven by a number of factors that are classed into two main categories.
Demand-pull inflation happens when the demand for goods and services outweighs the levels of supply. Imagine a popular new product that everyone wants to buy. If the supply can’t keep up with the high demand, prices will rise.
Cost-push inflation happens when the costs of production increase, leading businesses to raise prices to keep their profit margins. Things such as higher wages, increased raw material costs, or supply chain disruptions can contribute to cost-push inflation.
How Is Inflation Measured?
Inflation is regularly measured in two ways;
Consumer Price Index (CPI): The CPI tracks the price changes of a basket of goods and services typically used by the majority of regular people. It’s one of the most widely used indicators of inflation. For example, it includes items like food, housing, and transportation.
Retail Price Index (RPI): The RPI is another measure of inflation that includes a broader range of items compared to the CPI. It also takes into account the cost of housing and mortgage interest payments.
Understanding Inflation Rates
The inflation rate is the percentage increase in the price index over a specific period. For example, if the CPI was 100 last year and it’s 102 this year, the inflation rate would be 2%. This percentage reflects how much prices have increased over the year.
What Does Inflation Effect?
Money Worth: Inflation decreases the purchasing power of money. If your salary doesn’t increase at the same rate as inflation, you’ll find that you can’t buy as much with your income as you could before.
Your Savings: Inflation decreases the value of savings if they’re not invested in inflation-protected assets. For example, money kept in a savings account might lose value if the interest rate doesn’t keep up with inflation.
Investments: Inflation can affect investment returns. Stocks, real estate, and commodities often have some level of protection against inflation, but fixed-income investments like bonds may suffer if inflation is higher than expected.
The Economy: Moderate inflation is generally seen as a sign of a growing economy. However, high inflation, like we’ve seen across all parts of the world since 2020 can lead to uncertainty and reduced consumer spending, while deflation (a decrease in general price levels) can lead to decreased economic activity.
How Do Banks Manage Inflation?
To try and halt a sudden rise in inflation, central banks have a number of plans in place, such as:
Adjusting Interest Rates: By raising interest rates, borrowing becomes more expensive, which can reduce spending and slow down inflation. Lowering interest rates can also increase spending and investment.
Controlling Money Supply: Central banks can influence inflation by controlling the amount of money circulating in the economy. Reducing the money supply can help curb inflation, while increasing it can bring economic activity back up.
How Can I Deal with Inflation?
Invest Wisely: Consider investments that have historically outpaced inflation, such as equities or real estate.
Diversify: Spread your investments across different asset classes to manage risk.
Adjust Budgets: Regularly review and adjust your budget to account for changes in prices and income.
Summary
Especially in the current climate, understanding inflation and the ways you can manage the rise in the cost of living is key. By understanding what inflation is, its causes, and its effects, you can confidently make important decisions about the best ways to manage your finances. The current cost of living is difficult but by using strategic plans, researching previous trends in similar economic environments can help you not only get through these challenges but thrive!
Here at the GLOSS Vault, we have made it our mission to help as many people like you across Australia and New Zealand feel in control of your money and ensure you’re getting the most out of it. To find out more about us and what we do click here. If you’d like to see our app in action for yourself head here!