Inflation is a recent buzzword used by many people who may not necessarily know what it means to show how smart they are. You become wiser by not only knowing what it is but how it affects you in your daily life and how to make the right choices.

What is inflation? 

Inflation is the general increase in the prices of goods or services. For example, one day, you go to a supermarket and buy the same goods as the last time you went, but the total on the bill would be higher.

Your first instinct would be to check whether there’s a product that you may have bought by mistake. However, you realize that you didn’t buy anything besides your usual shopping list. 

Upon closer inspection, you discover that the goods you usually buy have increased their price. You’ll notice the increase in price not just for one item but all items in general. That’s inflation.

Inflation means that you need more money to buy the same goods. If you’re on a tight budget, you can buy fewer goods with the same amount of money, as they’re unaffordable.

In simple terms, your money would have lost its purchasing power. 

The European Central Bank targets around 2% inflation per year to maintain economic stability. For example, if you spent Euro 100 last year, you’ll need Euro 102 to be able to purchase the same goods.

Governments try to compensate for these increases by increasing wages through instruments like collective agreements and the private sector such as cost of living adjustments. The cost of the latter gets paid by the private sector. 

While 2% can be considered normal, lately, the inflation around the European Union was high as 8%. For example, you’ll need Euro 108 instead of Euro 100 or Euro 8 more to buy the same goods as one year ago.

There are plenty of causes of inflation attributed to the increase in the supply of money or scarcity. 

Money supply

An increase in money supply occurs when there’s too much money chasing a few goods. For example, a shop owner may sell a diamond ring that costs Euro 1,000, and 10 people can afford to buy it at that price. 

If the seller doubles the price to Euro 2,000, only two people may afford to buy it. The seller may get tempted to double the price to Euro 2,000 and make an extra Euro 1,000 profit, knowing that it will still sell the ring.

If the government were to handle Euro 1,000 to everyone, all the ten prospective buyers could again afford to buy the ring at the new Euro 2,000 price tag. Once again, the seller may increase the price to say Euro 3,000. The price increase would occur simply because the government increased the money supply.

Scarcity

If there’s a war and extraordinary events like COVID-19, prices tend to increase as it would be more challenging to obtain the goods or services. For example, during the two-year COVID-19 period, retailers could get their hands on lower quantities of goods or services due to lockdowns as they became scarce. Therefore the prices of certain goods increased as it became more expensive for the manufacturer to produce those goods.

The cause, in a nutshell

Governments worldwide bet that they need to stimulate the economy by investing in their economies and giving people spending money in the post-COVID-19 age. 

All the hope for an economic recovery faded away as Russia invaded Ukraine. Both countries are known for producing raw materials like oil and grain. Ukraine can’t produce anything because it’s fighting a war. At the same time, Russia cannot export its products because Western countries like the United States, European Union, and the United Kingdom are imposing sanctions.

Economies worldwide are dealing with two problems. The first was an increase in money supply as governments handed stimulus money to enable the global recovery from COVID-19. The second problem is the scarcity created by the war. 

Consumers tend to buy less and save more money if they’re facing a threat of scarcity and price increases. The two problems combined indicate that consumers have money that they are afraid to spend.

The repercussions

High levels of inflation can be quite dangerous. During periods of inflation, people tend to spend less due to fear of what may happen next. If consumers spend less, companies will produce less and be unprofitable, leading them to close their doors. In turn, this may lead to redundancies.

If the output of a country falls below previous levels, it could create a recession.

Surviving inflation

The average consumer can’t control inflation as geopolitics is a complex subject that only superpower countries can attempt to influence. Nonetheless, you can at least try to reduce or limit the impacts of inflation on your hard-earned money.

Like anything in life, good and bad times pass. We don’t want good times to pass, yet no one knows how long bad times last. Ideally, you’ll be well prepared to pass through unfavourable situations like inflation with minimal impact. 

As a consumer, your goal should be to preserve your money. The less you spend, the better. However, bills need to get paid, and food needs to get on the table.

The trick is to be frugal or economical. To be economical means to be moderate in your spending. 

Do you need to splash money out on designer clothes, or will beautiful unbranded clothes serve the same need? Do you need to buy the last phone that came out last month, or will it cost more than your average salary?

You have to distinguish between a need and a want. Needs are essential items, so you’ll still need to buy them regardless of your financial state. These include consumer essentials like food, healthcare and utilities.

On the other hand, Wants are non-essential items or things that you can survive without them. Wants are consumer discretionary as buying a car, appliances, entertainment and investing.