Inflation: What is it?

Inflation is one of those words that you hear all the time when you’re trying to catch up on finance news. You might be able to get the concept just by the context clues around it, but do you know what inflation is?

We’re going to break inflation down for you today. Well, not the actual inflation; that would mean we have some economic superpower. No, we’re going to break down what inflation means; and maybe break down in the process.

So, what is it already?

To put it in the simplest terms that might anger an economist, inflation is the rate at which things get more expensive. If the cost of bread was $1.50 last year and $3 this year, that means that the inflation on bread has grown 100 per cent.

A cut into a fresh loaf of bread

The world doesn’t calculate inflation via bread, but instead “basket of goods”, which gives a rough estimation that is used. This measure changes depending on the country, economic institutions, governments, and other measures, so some countries have higher or lower inflation than Australia.

Do we need inflation?

Without a PhD in economics, it can be tricky to explain why we need it. Don’t prices always rise? Well, yes and no. Overall, prices go up generally, but some goods are lower in value over time or the demand changes.

For instance, the “Demand-Pull Effect” is an economic term for the supply not meeting the demand of a product causing the price to rise. Usually, the supply increases, which brings the price back down even if the demand is still high.

On the flip side of the “Demand-Pull Effect” is the “Cost-Push Effect”, where the cost of materials increases which causes the overall cost to increase. A perfect example of this is petrol, and it’s doubtful that petrol will ever drop to 1980s prices.

Why is inflation different for different countries?

There are a lot of factors that can go into why the inflation rate of countries are what they are, but the main two are interest rates and money supply. When the Reserve Bank of Australia changes the interest rate, they are doing so to keep inflation under control. Does this always work? No. Sometimes factors like the Global Financial Crisis back in the early 2000s affect economies in such a big way that countries can’t fix the inflation rate, and we all feel the pressure in the pocket.

Why should you care about inflation?

Does inflation affect you? Of course. Inflation can have a massive effect on interest rates as they are the frontline tool used to keep it under control. Higher interest rates mean more mortgage repayments, lower interest rates mean you get less interest on your savings, and inflation can play havoc on the share markets, which means your investments can be in greater flux.

Man leaning his head against a chalkboard with math scrawled all over it

Inflation isn’t something that you should become obsessed with, or you could end up one of those folks scrawling math on the walls of their home with a sharpened stick level of obsession. It is, however, great to have a great understanding of how it’ll affect your financial goals.

If you would like to discuss your financial goals with our team of experts to see how you can try to “inflation-proof” your future, you can do that here.

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