Understanding inflation: What it is and how it works
If you feel that your basket at the supermarket is shrinking because of price increases across the board or your money is just not stretching as far as it used to, it could be because you’re feeling the effects of inflation on your budget.
Everything seems more expensive, and here’s why:
What is inflation?
Inflation is when the price of goods and services goes up and your money’s purchasing power (its buying capacity) decreases. It costs more to buy the same things, for example, if a loaf of bread used to cost R15 last year and now it costs R20 for the same loaf. The item isn’t changing, but the value of your money decreases, making it ‘worth less’ than it was before because you can do less with it.
The difference between inflation and price increase is that a price increase is usually in response to supply and demand and usually on individual products/services, but inflation is a steady increase in the price of most goods and services over a relatively quick period.
Why does inflation happen?
Inflation occurs for various reasons and one of them is when the economy experiences strong growth and people start spending more. As a result, the supply of money increases and surpasses the economy's growth rate. This stimulates the demand for goods and services, leading to an increase in prices.
When people have more money, they tend to spend more, which creates higher demand. However the supply of goods and services may not be able to keep up with the increased demand, causing prices to rise.
To curb this, the Reserve Bank will take the necessary steps to manage the money supply (i.e. how much consumers are able to spend) by increasing interest rates.
The cost of energy (e.g. fuel and electricity) going up also influences inflation as the economy depends on these to run. An increase in these has a knock-on effect on production, shipping and transport and, thus, increases the overall cost.
How inflation impacts you
- It lowers your money’s purchasing power: this means your money buys less than it did before, and you’ll have to pay more for the same products and services.
- Borrowing becomes more expensive: interest rates going up means the cost of accessing credit increases, making your home, car and personal loans more expensive, therefore, taking a bigger chunk out of your budget.
- Your income can’t keep up: if the rate of cost of living goes up but your income doesn’t rise at the same rate, it could affect your buying capacity and therefore, your standard of living.
- Your savings can shrink: if your savings don’t grow at the same rate as inflation, it means you’re essentially losing money because what you could’ve bought with that money decreases. This is particularly concerning for retirement savings because your money’s purchasing power will become less as the years progress.
Knowing how inflation affects your money and what you can do with it is important to effectively manage your investments, savings, loans and retirement plan. A registered financial professional can help you put plans and solutions in place to protect your financial future and minimise the effects of inflation.
Disclaimer: This article is solely intended for information. It does not constitute financial, tax or investment advice or recommendation. Please speak to a financial advisor or registered financial professional before making any financial decision(s).
Standard Bank, its subsidiaries or holding company, or any subsidiary of the holding company and all of its subsidiaries make no warranties or representations (implied or otherwise) as to the accuracy, completeness or fitness for purpose of the information provided in this article or that it is free from errors or omissions.
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