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 smartphones 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 (RBA) 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.
- Your loans. The RBA tends to use interest rates as its primary tool to control inflation. As inflation rises, the RBA 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.
The following table shows how much you would need to spend today to equal $10 spent in each of the following years:
If you have any questions, please speak to your Financial Adviser.
Our financial advisers Bruno Tjelder and Damon Zischke and OBT Financial Planning Pty Ltd are Authorised Representatives of Lonsdale Financial Group Ltd ABN 76 006 637 225 | AFSL 246934.
This is general advice only and does not take into account your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or seek advice from a financial planner and seek tax advice from a registered tax agent. Information is current at the date of issue and may change. This information and certain references, where indicated, are taken from sources believed to be accurate and correct. To the extent permitted by the Law, Lonsdale, its representatives, officers and employees accept no liability for any person that relies upon the information contained herein. Information is current at the date of issue and may change.