What is Inflation?
Remember when you could get a childhood chocolate bar for $1 but it’s now $4? That’s inflation at play.
Due to inflation, the money in your savings account is losing value – that’s why you should invest.
KEY TAKEAWAYS
- Inflation is a term used to describe the average rate that prices increase by
- Generally, it's accompanied with economic growth and allows for the adjustment of prices across an economy
- Investing in stocks and shares can protect yourself against higher rates of inflation
- Not investing means your money stays in the bank whilst depreciating in value
Why does Inflation Happen?
Inflation is a term used to describe the average rate that prices increase by. Remember when you could get a childhood chocolate bar for $1 but it’s now $4? That’s inflation at play.
Due to inflation, the money in your savings account is losing value – that’s why you should invest.
Understanding why inflation is suddenly top of our agenda is crucial for both your daily life and your investments.
Inflation is integral to our lives, economies and investments. However, it’s been so stagnant there have been virtually no talking points over the last decade. That’s all set to change and boy, it is making the headlines.
Pros and Cons of Inflation
On the bright side, inflation can help to balance out wage increases. Generally it is accompanied with economic growth and allows for the adjustment of prices across an economy.
Deflation, or a lack of inflation, can create uncertainty and this can lead to market sell offs and recessions. It can also mean that savings lose their ‘real’ value and wages aren’t aligned with the cost of normal purchases.
This is big news when it comes to cash savings vs investments. If the inflation rate suddenly goes up to 5% per year, and you’re getting 1% returns, your savings will be worth 4% less than they were last year.
What does Inflation Have to do with Investing?
Investing in stocks and shares has yielded 8-10% per year on average over time, meaning you can protect yourself against higher rates of inflation. But don’t be fooled – that growth will still face the same ‘real’ loss as cash in the bank.
Inflation can also affect currency competitiveness. So, let’s say you’re buying stocks and shares from Japan, in Japanese Yen (JPY) and you are based in France purchasing your investments in Euros (EUR). If the JPY experiences high levels of inflation, then it becomes more expensive to buy with EUR. Over time, this erodes competitiveness with the Euro and other global currencies, resulting in your investments losing money despite seeing growth. Are you a bit mind boggled yet?!
In a nutshell, inflation is one to watch when you’re holding cash in the bank, buying overseas stocks and commodities or watching your budget and changing price levels. There’s not a lot we can do to change it, but understanding it is important in order to protect ourselves against the consequences.
3 Effects Explaining Inflation: Demand-Pull, Cost-Push, and Built-In
If macroeconomic jargon feels a bit intimidating but you want to learn more about how inflation is affected on a macro level, here’s 3 effects:
Demand-Pull
Demand-pull inflation occurs when the overall demand for goods or services increases faster than the production capacity of the economy. When demand-pull happens, there will become a demand-supply gap.
Cost-Push
Cost-push inflation happens when there is an increase in the cost of a production. This could be due to higher prices on the material being used. So when it gets more expensive to produce, the end product will be more expensive. This is the effect of cost-push inflation.
Built-in inflation
People know about inflation which means that they expect and demand higher wages to maintain their cost of living. When a company has to raise their wages, it will result in higher costs of production and which we know from cost-push will result in higher prices.