What does inflation mean?
What is inflation? Inflation is the rate at which the prices of goods and services increase. As a result of inflation, the value of your money decreases so you get less for the same amount of money you needed before. The prices of certain goods and services may also rise from time to time for reasons unrelated to inflation. The term inflation is used when the general price level rises over a sustained period.
What causes inflation?
- A central bank prints too much money, reducing the value of money.
- Demand for goods and services exceeds businesses’ ability to produce them.
- Production costs rise, forcing companies to push up their prices to offset the higher costs.
- Expectations of rising inflation may fuel demands for wage increases, which forces businesses to hike prices. Inflation expectations can therefore become a self-fulfilling prophecy.
How does inflation affect your savings?
Holding your money in a savings account may feel like a safe choice but inflation eats away at the value of your savings in the long term. When prices go up, you won’t be able to buy as many goods and services as before. Below is an example of how the value of your money may decrease over time and what you should do to grow your savings instead.
Example of inflation: Prices rise and purchasing power decreases
With annual inflation of 2%, groceries that cost you 100 euros one year will cost you 102 euros the next year. When prices go up, your purchasing power decreases and you won’t be able to afford to buy as much as you once did. Let’s say inflation rises by 2% every year for the next 10 years. The same groceries will cost you 122 euros in 10 years (100*1.02^10). If you have the 100 euros in a savings account, you’ll be able to afford just 82% of the same groceries in 10 years’ time.
Simply put, the value of your 100 euros will go down 18% over 10 years with an annual inflation rate of 2%.
What does stagflation mean?
In economics, the term stagflation is used to describe a period of very slow economic growth (stagnation) and high unemployment accompanied by a rapid increase in the general price level (inflation). Typically, inflation has an inverse relationship with economic growth and unemployment. Stagflation is generally thought to be caused by supply shocks, bad monetary and fiscal policies, or a combination of the two.