Understanding Inflation
We have all heard about inflation, but what is inflation, and does inflation affect our lives?
For those in their 40s and 50s, they must still remember that nasi lemak once cost only RM2 with all the ingredients and side dish remaining intact as it should be.
However, the price increases over time, and the serving of each nasi lemak also gets smaller, with little or no anchovies and a slice of a cucumber and boiled egg.
We notice the changes, but there is not little we can do as we continue with our lives, struggling to meet end needs.
The changes in price, sizes, offerings, and whatnot is what we call inflation. Basically, inflation eroded the value of money. Thus, we take home less every time we shop or pay more for the services we need.
Inflation Definition
Inflation is the rate at which the general level of prices for goods and services rises, causing purchasing power to fall. As inflation increases, each currency unit buys fewer goods and services.
Here are some key points to understand about inflation and the value of money:
How Inflation Affects Your Value of Money
1. Purchasing Power
When inflation rises, the purchasing power of money decreases. This means you need more money to buy the same amount of goods and services.
2. Cost of Living
Higher inflation leads to an increase in the cost of living as everyday expenses like food, housing, and healthcare become more expensive.
3. Savings and Investments
Inflation can erode the value of savings if the interest rate on savings accounts is lower than the inflation rate. However, certain investments, like stocks or real estate, may offer returns that outpace inflation.
4. Wages
Ideally, wages should increase at a rate that matches or exceeds inflation to maintain purchasing power. However, this isn't always the case, leading to decreased real income.
Types of Inflation
1. Demand-Pull Inflation: This occurs when demand for goods and services exceeds supply, driving prices up.
2. Cost-Push Inflation: This happens when the costs of production increase, leading to higher prices for finished goods and services.
3. Built-In Inflation: Results from adaptive expectations, where businesses and workers expect prices to rise and thus increase prices and wages accordingly.
Managing Inflation
Governments and central banks use various tools to manage inflation, such as:
- Monetary Policy: Adjusting interest rates and controlling the money supply.
- Fiscal Policy: Changing tax rates and government spending to influence the economy.
Understanding inflation is crucial for making informed financial decisions, whether budgeting, saving, or investing.