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Inflation: What it means for your wallet and how it impacts your life

Inflation is a global phenomenon that continues to rise. But what is inflation? ZDNet explains what it is and how it affects your cost of living.
charlie-osborne
Written by Charlie Osborne, Contributing Writer on
Reviewed by Marc Wojno

Inflation continues to surge across countries including the United States and the United Kingdom. 

When you hear that inflation is on the rise and you see headlines with record-breaking increases, such as in Sri Lanka where inflation has peaked at 39%, it sounds dire. But percentages don't translate well into what this actually means for you. 

There are many contributing factors that are used to determine the rate of inflation and different organizations, depending on the country, come up with the figure. At the time of writing, many countries around the world are experiencing their highest rates of inflation in decades. 

But what does inflation actually mean, and how does it impact us?

What is inflation?

Inflation, as a general term, is the diminishing purchasing power of a given currency over a period of time. It's a measure of the increased price of goods and services in an economy. 

Inflation can be measured in months or years. When the price of goods increases and is sustained over a period of time, inflation then puts pressure on consumers and reduces their purchasing power. 

When rates of inflation are high and sustained over time, this reduces the value of the money in our wallets and our bank accounts.

Inflation is a broad term used to measure the overall picture of price rises in an economy. For example, inflation can factor in the cost of essentials including electricity, gas, clothing, and food, as well as public transport, electronics, and "luxury" goods. 

The takeaway is: The higher the inflation level, the less purchasing power your money has

Economically, there are several major types of inflation that economies face. You can have demand-pull inflation caused by demand and economic growth that is going too fast; cost-push inflation when businesses are forced to increase their prices due to the higher price of raw goods and materials, and built-in inflation, prompted by workers who expect their wages to go up in line with the increased costs of goods and services. 

Examples, by the numbers

  • A loaf of bread cost you $1.00 in 2021. This year, that same loaf costs you $1.10. That means the price has inflated by 10%. 
  • In the UK, energy bills are soaring as price caps increase. If a homeowner paid £200 a month last year, on average, and is now paying £400, inflation is set at 100%, as they're paying double.
  • Let's say you paid $50 per month, last year, on pet food. You're now paying $80 per month. This is a price increase/price inflation of 60%. 

You may also see downward trends in the cost of some goods and services. For example, if the general public is having to spend more on essential day-to-day goods and services, they may choose to forgo items considered "luxury" or "optional," such as buying a new car or renovating a house. 

Businesses that sell luxury goods and services may cut their prices to entice consumers to spend their disposable income, whereas otherwise, they may have delayed non-essential purchases. For example, if a hot tub costs you $5,000 in 2021 but the average price has now dropped to $4,500, this is a discount of $500, or 10%, or deflation of 10%. (Prices, however, would need to be down across the board and not just with a handful of individual suppliers to be considered deflation.)

Who decides the rate of inflation?

The rate of inflation is decided and reported individually by countries that use different measures. 

In the United States, the Bureau of Labor Statistics (BLS) calculates the Consumer Price Index (CPI). The US Department of Commerce's Bureau of Economic Analysis (BEA) produces a Personal Consumption Expenditures Price (PCE) index. 

The Federal Reserve monitors any changes in these indexes, as well as general market trends, and may change monetary policies to try and keep inflation under control and economic growth on the up. 

The Federal Open Markets Committee (FOMC) aims for inflation to stay around the 2% mark.

In the United Kingdom, the Office for National Statistics (ONS) checks the prices of popular and necessary goods, including travel and home expenses, fuel, energy, and food to set the current CPI. This is used together with the Consumer Prices Index including owner occupiers' housing costs (CPIH), including household rental 'equivalence' and general housing costs, to try and maintain a more robust and accurate picture of true household expenditure and disposable income. 

The agency also monitors producer price inflation, the measure of prices for goods bought and sold by UK manufacturers. If these costs go up, the price is often passed to the consumer. 

As shown in the screenshot below, the ONS tracks items individually, and their cost increases or decreases. Popular food items include sliced white bread, basmati rice, crumpets (of course), baked beans, and meat products.

screenshot-2022-06-30-at-16-52-16.png
ONS

It's the Bank of England's job to try and tweak monetary policy to keep inflation at a healthy level. The current target is also 2%. 

What impacts inflation?

There are many factors that can cause inflation to rise or decline. Such factors include:

  • Political instability: Political instability, in-country fighting, poor or failing monetary policies, and political sanctions can all impact the way an economy performs as well as the supply of products and services. 
  • War and conflicts: When there are conflicts, this can lead to problems with the supply of raw materials, industrial products, and special items from countries involved in these situations. The invasion of Ukraine by Russia, for example, has caused supply problems with grain and rapeseed oil, pushing up the price of consumer products that require them, as well as alternative oil types. 
  • Supply chain disruption: Whether it's due to a lack of raw material, sanctions, cyberattacks, high demand, or companies going bust, supply chain disruption can cause supply problems that push up the price of available items. 
  • International price hikes, exports: If manufacturers need to pay more for imported goods, this cost is often passed to the consumer. Governments may also place high duties on exports to raise funds to tackle their country's fiscal problems.
  • Interest rates: If interest rates, the amount you have to spend to borrow money -- such as for a mortgage -- are low, money is 'cheap.' However, by increasing interest rates, you make it more expensive to borrow money. If you increase the price of borrowing, this can deter expenditure, and so (in theory) demand falls -- and so does the price, and inflation cools down. While you may be deterred from borrowing by interest rate rises, on the flip side, this may also mean that you earn a little more from your savings. 
  • Printing money: Money supply policies can increase or reduce inflation. If too much money is added to the circulation, this can -- in theory -- be clawed back through higher-rate taxation and can be used to pay off the national debt. However, this method can also devalue a currency and become a catalyst for inflation and a recession.

How does inflation affect my wallet?

When inflation isn't controlled and on the rise, this directly impacts how much real-world value your money has. 

For example, if inflation is at 15% year-over-year, your money will get you 15% less than it did last year -- in theory. 

However, inflation is an umbrella that determines an average rate of price hikes, so inflation impacts everyone in different ways. For example, a family who uses two cars and has two children may be disproportionately impacted due to their increased need for fuel, energy, and food, in comparison to an individual living at home with their parents without a vehicle. 

On the other hand, high inflation, when housing is considered, could also affect that individual deeply, just in a different way -- for example, they may not be able to move out due to a surge in rental costs, and may not be able to afford to purchase a car because of the rising cost to buy one.  

In other examples, a family on benefits in the UK, or pensioners on a fixed income, could feel the sting mostly due to food and energy-related inflation, whereas a taxi driver who has to run their own car to work might feel the impact of rising fuel prices the most. 

There's no clear-cut 'this is how inflation will impact you' answer. Depending on your circumstances, inflation rising across the board will impact you in different ways -- and as many of us are already experiencing it when we pay more for what's in our shopping basket, the smaller increases all add up to carve away at our disposable income. 

Wages and the threat of a recession

Some countries are experiencing unrest due to low, cut, or stagnant wages, with individuals struggling to make ends meet as prices continue to climb. In the UK, for example, strikes are occurring in the public transport and legal sectors, with aviation potentially next.

However, there may be fears of inducing what is known as an inflation spiral if wages increase too much. This could create a situation in which prices continue to climb as a reaction to rising wages -- bouncing off each other and creating a cause and effect scenario that could inadvertently sustain inflation for longer than it otherwise would have lasted.

To define a situation as a recession, you need the data first -- and this often means we are in one before we realize it. According to the according to the US National Bureau of Economic Research, a recession is when an economy suffers significant negative economic growth lasting more than a few months as seen in real GDP, income, employment, industrial production, and wholesale-retail sales. It's also possible for inflation and a recession to occur at the same time. 

In our current situation, it's possible that high rates of inflation could either contribute to, or inadvertently trigger, a recession. Monetary measures designed to cool inflation could lower demand and growth, and if this goes too far -- with prices high, businesses going bust, people losing their jobs, and low investment levels -- we may end up in a recession. 

Inflation around the world

  • The United States: The inflation rate in May was 8.6%, the highest recorded since 1981.
  • The United Kingdom: The UK's inflation rate is 9.1% and is predicted to reach at least 11% in the coming months. 
  • Sri Lanka: In May, food inflation rose by 57.4% and non-food inflation climbed by 30.6%. Following months of food, fuel, and electricity shortages, Sri Lanka's Prime Minister Ranil Wickremesinghe said the country's economy has "completely collapsed."
  • Turkey: Turkey's inflation rate has surged to 73.5% year-on-year, with food-related inflation topping 91.6%. 
  • Brazil: The current rate is 12.1%. The government is rushing to cut duty rates on imported goods to ease the pressure on consumers. 
  • Russia: Russia's inflation rate is approximately 17%
  • Canada: Canada's inflation is on the rise and reached 7.7% in May, a 40-year high. 
  • Mexico: Inflation rose to 7.65% in May, a marginal decline from 7.68% in April.

FAQ

Is inflation good or bad?

Inflation is neither. While extremely high levels of inflation can have stressful consequences for the general public who suddenly find they aren't able to afford the goods and services they used to be able to enjoy -- or even, in some cases, the bare necessities of living -- keeping inflation at a comfortable rate, often pegged around 2%, is thought to promote economic growth.

What can be done to bring inflation down?

On the individual level, not much. It takes state-level action from governors and financial authorities, and this could include slicing duty rates, changing tax levels, or upping interest rates. However, managing inflation and the risk of recession is a balancing act.

What happens if inflation goes too high?

From 2007 until 2009, Zimbabwe's inflation/price level went up by 80 billion percent in only one month. Citizens then stopped using local currency, instead turning to barter when they could, and the economy came to a screeching halt. 

This is known as hyperinflation and it takes drastic and disastrous monetary policy changes or economic issues to trigger hyperinflation from high inflation. 

Bloomberg reported on June 30 that Sri Lanka has just entered the hyperinflation zone. The country relies on foreign exchange reserves to import fuel and a range of essential goods, and with only millions of dollars left and a chronic shortage of fuel and other supplies, the CPI has now gone beyond 54.6%. 

Key terms:

  • Inflation: A sustained rise in the price of goods or services in an economy. 
  • Hyperinflation: Accelerating and uncontrollable inflation of prices month-on-month, typically exceeding 50%. 
  • Deflation: A sustained drop in the price of goods and services in connection with a contraction in the money supply and credit in the economy.
  • Stagflation: Stagflation is a government nightmare. The term is a rough mix of stagnation and inflation, combining high prices for goods and services and a lack of economic growth, caused by a lack of disposable income available to households and often high unemployment. 
  • Interest rates: The amount you are charged for borrowing money, whether it is finance for a car, a personal loan, or a mortgage. 
  • Consumer Price Index: The CPI of a country measures a "basket" of popular goods and services and its price changes over time. This can provide a picture of inflation and the costs incurred by the general public in an economy. 
  • Recession: A recession is an impactful decline in economic activity. This may include high levels of unemployment, pay cuts, businesses closing, individuals cutting their spending, and a drop in Gross Domestic Product (GDP). Recessions are generally categorized after the fact and usually last longer than six months. 

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