What is inflation? (easy explanation)-
Introduction 👋
We’re constantly hearing “inflation this” and “inflation that” on the news, and that “inflation is rising”. 📺
But what actually is inflation? 🤷♀️
And why should we care about it? 🤔
Today we’re going to explain what inflation is and why it’s important, in the simplest way possible. ✨
Disclaimer: This website provides information for guidance and educational purposes only. The Grown-Up School does not provide regulated financial advice. You can seek independent financial advice from a suitably qualified and regulated professional advisor. Check out our disclaimer policy for more information.
What is inflation? 🎈
In simple terms, inflation is “prices going up”. 📈
More specifically – inflation is where:
- Prices go up everywhere ⬆️🛒🏷️
- You can’t buy as much stuff because prices are higher, so technically the value of your money goes down ⬇️💸😢
How the “value of money” goes down ⬇️
Imagine you’re going to the supermarket. 🛒🥦
For £50 you buy a big basket of shopping. Yay! 🧺
Imagine the next day, the prices of everything DOUBLED. 😨
To buy all the same stuff, you’d have to pay £100 instead of £50.
You’d be really annoyed, right? 😡
Suddenly your £50 is worth less – yesterday it was worth a big basket of shopping, but now you can only buy half a basket! 😟🧺
Inflation is talked about as a percentage 🤓
You’ll hear inflation talked about in ways like: “inflation is going to rise 4% this year”.
This basically means that prices in general are rising by 4% for the year. 📈
A lot of countries consider anything higher than 2% inflation as a bad thing. 👎
Why inflation is annoying 😠
Inflation can be a really frustrating problem when it comes to looking after your money – here are some of the main reasons why! 💵
1. Making shopping more expensive 🛒
If inflation is high, it means that prices everywhere go up. ⬆️
This means that essential things like food, water and energy get more expensive.
If you’re:
- struggling with money 🌪️
- not earning a lot 💸
- older and living off your life savings 🧓
These price rises can hit you really hard. 🥊
2. How much your wages are worth 💸
When was your last pay rise? 🕵️♀️
If inflation is high, it means that the value of your money goes down. ⬇️
This means if you’re not getting a pay rise at work, you’re technically getting a pay cut (because of inflation!) ✂️
If inflation for the year rises by 5% and you DON’T get a pay rise – this means you’re technically getting a 5% pay cut.
Ideally, you want your pay rise to either:
- match inflation so you’re not losing money 💸 e.g. if inflation was 5%, get a 5% pay rise
- beat inflation so that you’re earning more money 🤑 e.g. if inflation was 5%, get a 7% pay rise
If inflation is high for your country right now, it’s really important to consider how much money you’re “losing”, by not getting a pay rise.
3. How much your savings are worth 🐷
Have you got money stashed away in savings? 🐿️
How much extra money (interest) does the bank pay you, to say “thank you” for your savings? 🕵️♀️
What is interest? (easy explanation) 📈
If inflation is high, your savings are worth less money. 😢
If inflation for the year rises by 5% and you DON’T earn any interest from the bank on your savings– this means you’re technically losing 5% of your savings.
Ideally, you want your bank account to either:
- match inflation so you’re not losing money 💸 e.g. if inflation was 5%, get 5% interest
- beat inflation so that you’re earning more money 🤑 e.g. if inflation was 5%, get 7% interest
If inflation is high for your country right now, it’s really important to consider how much money you’re “losing”, by not getting paid interest for your bank accounts. 💸
If you’re in the UK, Money Saving Expert compares hundreds of accounts and regularly publishes a list of savings accounts with the best interest rates here. ⬇️
https://www.moneysavingexpert.com/savings/savings-accounts-best-interest/
You might notice however, that sometimes there aren’t any saving accounts that beat the current inflation rate. 🎈
This is why a lot of people invest in businesses instead, to try and make more money with some of their savings. 📈
4. Borrowing money gets more expensive 💸
A lot of people start borrowing money when prices go up (and inflation is high), so the price for borrowing money tends to go up too. 📈
This means that:
- If you want to borrow money, they might ask you to pay higher interest than usual – What is interest? (easy explanation) 📈
- If you’ve already borrowed money e.g. to buy a house, and your price isn’t “fixed” (variable rate loans), then you could be asked to pay higher interest than usual too. 📊
- It can become more difficult to buy a house, because loans for buying houses become more expensive. 🏠
5. It makes things unpredictable 🌪️
Inflation can also be really annoying because you don’t know how much prices are going to change.
This can make it really difficult to plan your spending. 📆
What causes inflation? 🤷♀️
Inflation can have a huge impact on your finances, so what causes it? 🧐
There are 5 main causes for inflation:
1. Demand 🤩
Imagine if every person in the world decided to go on a “chocolate diet” where they eat ONLY chocolate. 🌎🍫
Everyone would be demanding chocolate, and emptying out the supermarkets. 🛒
Chocolate would become really valuble and the price would go up a lot because everyone wants it! 📈
If people really want to buy something and create a huge “demand” for it, this can cause inflation too and make prices go up. ⬆️
2. Business Costs ⚙️
Another cause of prices going up is when business costs go up. 💰
If businesses have to pay more for things like:
- materials to make things 🛠️
- wages for their staff 💷
- tax to the government 🏛️
They have to put up their prices! 📈
If it’s more expensive to make products to sell, business owners have to put the prices up to make sure they still make money! 💸
3. More money 💸
Did you know that the government can print more money? 🖨️
This has to be carefully controlled, because when the government prints money:
- People have more money – which makes them more likely to spend it
- If people spend their money they create demand
- Demand creates inflation 🎈
Did you know? 🤔
In 1923 in Germany, way too much money was printed by the government so it lost its value.
People had to carry big piles of their money in wheelbarrows to the shops to buy things!! 🛒
4. Increasing wages 💰
Did you know that if lots of people get pay rises – this creates inflation too! 💼
If lots of people get pay rises:
- People have more money – which makes them more likely to spend it
- If people spend their money they create demand
- Demand creates inflation 🎈
5. Government decisions 🏛️
You’ll find in every country the government will work really hard to control inflation. ⛓️
They can make decisions that either cause inflation, or reduce inflation. 📊
In the UK you have the government’s “Bank of England”, who work hard to control inflation.
https://www.bankofengland.co.uk/
In the USA, you have the government’s “Federal Reserve”, who work hard to control inflation.
https://www.federalreserve.gov/
Most countries set targets for inflation, with a lot of governments trying to keep inflation as low as 2% every year.
Governments can do a lot of different things to try and control inflation, such as:
- Printing more money
- Increasing or reducing tax
- Giving money to people
- Lending money to banks (they can choose to make it really cheap for banks, or really expensive)
Conclusion 👍
If you’ve made it all the way to the end of this article, well done!
Inflation can be quite confusing to learn about.
The 3 main things to remember about inflation are:
- Inflation = prices going up ⬆️ + the value of your money going down ⬇️
- Inflation is usually talked about as a percentage!
- There are things you can do e.g. asking for a pay rise, comparing savings accounts, investing, to help stop inflation from hurting your finances.
So that’s it!
Hopefully you’re feeling more confident about understanding how inflation works.
If you know any friends or family members who might benefit from learning about inflation, share this post with them!
Finally, don’t forget to check out our similar articles below!
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Is borrowing money a bad thing? 🤷♀️
How to keep control of your money 💸
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