Inflation is a hot topic at the moment. But what exactly is it, and how does it affect you and your money?
Inflation is making news daily through wage inflation, energy inflation, food inflation, fuel inflation... and not just in Australia, but in many other countries too. In simple terms, inflation means that the prices of everyday things are rising. Why does this matter? It means that unless our incomes rise in line with inflation, our money doesn’t go as far, and we might find it more difficult to buy the kinds of things that we’re used to having.
How high is inflation?
According to the most commonly used measure of inflation in Australia, the Consumer Price Index (CPI), inflation increased by 0.8% in the July to September 2021 quarter and rose 3% over the 12 months to September 2021.
Why does inflation happen?
There are two main causes of inflation:
- “Cost push inflation” is where the costs of producing goods or services goes up, and so price rises are passed onto customers.
- “Demand pull inflation” is when something is so popular that the supplier can’t meet the demand. Prices go up to reflect the lack of supply.
How is inflation measured?
The official Australian inflation measures come from the Australian Bureau of Statistics (ABS), which tracks prices of a ‘basket’ of commonly purchased goods and services. This is supposed to represent the spending of the average Australian household. As people’s buying habits change, so do the goods and services that the ABS tracks.
For example, in recent years, the ABS has added streaming services, ride sharing and smart phones to the CPI basket and removed items such as DVD hiring, cassette tapes and VCRs from the basket to more adequately represent the average household expenditure.
How is inflation controlled?
The Reserve Bank of Australia has a specific responsibility for low and stable inflation, full employment, and promoting the general welfare of the Australian people. The government has set a target of 2-3% for inflation, on average over time.
What does rising or high inflation mean for...
- ...your spending: Rising prices of goods and services will mean that unless your income rises too, you will find it more difficult to afford the things you normally buy. Sharp movements in the rate of inflation are not helpful either, because they make it difficult for people to plan their spending. For example, rising inflation can trigger “buy now while stocks last” behaviour.
- ...your savings: If your savings don’t grow at a rate at least equal to inflation your wealth is shrinking. For example, inflation is now running at 3%, but cash in a current account is likely to earn less than 0.10% interest. Its value is being quietly eroded with every day that passes. This effect of inflation is easier to see by looking back in history.
The following table shows how much you would need to spend today to equal $10 spent in each of the following years:
Goods and services costing $10 in…
Would now cost…
ABS CPI as at 30 September 2021
- ...your loans: The Reserve Bank tends to use interest rates as its primary tool to control inflation. As inflation rises, the Reserve Bank tends to be more willing to raise interest rates – meaning mortgages, loans and credit cards can become more expensive.
- ...your investing: when inflation is rising, or already high, holding assets such as shares, property and bonds (or even foreign currency) can be more attractive than keeping your cash in a bank account (because, as inflation rises, the value of cash tends to fall relative to other types of assets) – but shifts in inflation and interest rate expectations can also spook investors, creating volatility and unpredictability in asset prices.
If you have any questions, please speak to your Financial Adviser.