Have you ever heard an older person complaining about how, back in ‘their day,’ candy bars cost twenty pence?
Sounds unlikely, but if you look it up, you’ll find out that they’re not misremembering things – candy bars really did once cost a lot less than they do now. The reason they cost so much more now is because they have been impacted by inflation.
What is Inflation?
Inflation refers to the economic phenomenon that lowers the value of money over time. It’s triggered by rising demand in the market and is generally measured at around 1-3%/year in developed economies using the Consumer Price Index (CPI).
This means that the set of goods that government economists have determined that the average family is likely to purchase (fuel, food, clothing, etc.) has increased in cost by that 1-3% in that given year because most people were willing and able to pay that much more.
These increases are cumulative, leading to situation in which costs have risen by 15-20% after a few years.
If your wages don’t rise enough every year to beat inflation, you’ll find yourself needing to be more and more careful with your money as the years go by; the same nominal amount will buy less.
Inflation can impact the entire economy or just a single isolated consumer category, too. Sometimes a particular good or service will rise in price faster than a person’s other expenses do: housing is a particularly relevant example in the UK right now. Its cost has risen far more quickly than the overall rate of inflation.
Exceptions like these are driven by many complicated factors, but in the case of housing, we can guess that a growing population may have caused more demand for the finite amount of living spaces in the country – this makes land significantly more valuable and drives up home prices.
The inverse of inflation (when money increases in value over time instead) is called deflation, but it’s much less common. Deflation only occurs when demand falls.
You can best observe its effects by looking at the price fluctuation of fad products that debuted at a high price but became much less valuable later on when the hype died down (think Beanie Babies, Furbies and Fidget Spinners, to name a few).
Conditions like these rarely occur in the overall market due to the easy availability of credit and the ever-expanding consumer population, so when planning for the future, it’s prudent to assume that inflation will continue unabated as it generally does.
Inflation and Savings
As mentioned above, inflation is at its most vicious when it’s working over long periods of time – this means that in the case of long-term savings, whatever money you put away will almost inevitably be worth significantly less when you finally withdraw it.
This is why simply saving every penny you can isn’t always a good idea. If you can’t secure a rate of interest that will beat inflation or your saved amount is particularly small, you may be better off spending that money right away when it has its full purchasing power still intact.
If you’re really committed to the idea of saving, it may be best to invest your money rather than leaving it stagnant in a bank account. If you choose your investments carefully, you should be able to earn enough of a return to counteract the effects of inflation and even get a little extra profit.