What is inflation?

What is inflation?

In simple terms, inflation measures the rate of price increase in the economy for general goods, services and many other areas. As prices increase around us, a certain amount of money will allow you to purchase fewer services and goods than before. Such a development impacts the general cost of living for many of us and can become a problem when it leads to the deceleration of economic growth. 

What causes inflation?

Throughout history, the economy has been subject to periodic economic changes caused by inflation. The reasons and effects of inflation are disputed, but some popular distinctions are Demand-Pull inflation, Cost-Push inflation and Built-In inflation. 

What is Demand-Pull inflation?

Demand-Pull inflation is a result of an imbalance between demand and supply and it’s the most common cause of inflation. When the total demand for goods and services by the public is much higher than the supply of said goods and services, then a gap is created. If many consumers want to buy certain goods, this results in higher prices and, in the end, leads to an overall higher cost of living for everyone. 

This development often happens during an economic upswing. A rise in employment in an economy means more disposable income to the general public, which leads to higher spending. This increase in demand ultimately leads to a rise in the price of goods and services.

What is Cost-Push inflation?

Cost-Push inflation is the result of an increase in price during the production or manufacture of goods. If goods cost more to manufacture, this ultimately increases the market price for buyers. For example, a company has to increase the labour cost of manufacturing their sunglasses by hiring more employees and getting more expensive materials. Since the company had to pay a higher cost for the production of the sunglasses, they increased the market price in order to make a profit from selling them. 

What is Built-In inflation?

Built-In inflation occurs when prices in an economy rise and workers expect higher wages in order to support their cost of living. This causes a slippery slope of problems because higher wages lead to higher demand, higher demand leads to higher market prices which results in, you guessed it, inflation.

Why is inflation important for cash holders?

Inflation can be seen as either a good or bad thing, depending on your position. Inflation may not mean positive news for those who only save cash in their bank account, as inflation devalues their cash holdings, i.e. your funds end up with less purchasing power and won’t generate returns if the rate of inflation is higher than the interest rate for the savings account.

Why is inflation important for investors?

Inflation often favours those who invest. Investors with tangible assets such as stocks or commodities hope for inflation in markets that affect their investments, as it increases demand and they can then sell their holdings for a higher price. In turn, buyers of said assets would have to spend more money on what was once a lot cheaper. That is why, as an investor, it is a good idea to invest a fixed monthly amount of your disposable income in financial products of your choice to avoid your savings being the target of inflation.