How Inflation Impacts Your Finances

How Inflation Impacts Your Finances

Inflation, in a nutshell, is a rate or figure that directly affects the prices of goods and services. A higher inflation rate reduces the buying power of consumers, which is why you need to watch inflation rates very closely. Central banks have the responsibility to ensure that neither severe inflation nor severe deflation occurs, and often implement curbing measures to keep price increases in check.

Inflation rates have always been somewhat of a puzzle to investors and individual citizens alike. Inflation is the reason for the gap between the prices of basic goods today from say, 60 years ago. When doing your own personal planning, it is important that you:
  • Pay attention to long-term inflation rates
  • Consider inflation when you go for investments such as deposit accounts, bonds, and insurance plans that boost your personal finances
  • Set realistic expectations in planning for your financial future. For instance, you need to consider the living and healthcare costs by the time you retire

Forces Behind Inflation

The general public is not often aware of the reasons for inflation and deflation. The one primary cause is actually subject to debate, and economists mostly agree that inflation rates are driven by a variety of factors. There are two generally accepted theories as to what causes prices to rise or fall:

Demand-Pull

Demand-pull is when aggregate demand is growing at a faster rate than supply, causing prices to increase. This commonly occurs in growing economies when there is a sudden increase in the amount of money and a decrease in taxes on goods. By aggregate demand, we mean a combination of consumer spending, government spending, investments, and what’s left after you subtract imports from exports. 

Cost-Push

Cost-push inflation happens when business costs go up and companies are left with no choice but to raise their prices in order to maintain profitability. When wages, business taxes, and import costs go up, companies and manufacturers pass on the additional costs to their customers. Shortages can also cause the cost-push inflation effect.

Other driving factors for inflation may also include market power, asset market boom, and supply shock.

Taking Advantage of Low Inflation

In recent years, however, prices have been rising very slowly, with the OECD announcing in June that the world’s inflation rate was the lowest in more than two years. But since inflation rates surged to double-digit levels in the 70s, the public is often fearful or anxious where inflation is concerned.

Lower inflation is considered good news for individual savers and investors for many reasons, some of which are the following:

Better Returns on Time Deposits

Time deposits are considered the safest form of investments, wherein you deposit funds into a bank and allow it to grow on a set interest within a locked-in period. If inflation rates remain low, your money does not lose purchasing power and you can afford to keep it in the bank for a longer period.

Increased Saving Potential

There is no stopping rising living costs every year. However, lower inflation rates—such as the world economy is exhibiting now—allows consumers to buy more with their income and still have enough shekels to save in a deposit or insurance account to boost your personal finances.

Affordable Loans

Central banks also consider inflation rates for disbursing loans. Lower inflation lowers interest rates on loans making it more affordable for borrowers to make repayments.

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