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Inflation

Inflation is the progressive increase of prices over time. For example, if the average price of goods and services goes up in price by 10%, then the rate of inflation is 10%.

As a result of inflation your $10 note now buys less, because you need 10% more to buy what you did in the past with that note.

Two popular theories about what causes inflation are:

  • There is too much money chasing too few goods. If there is more demand for goods than supply then their prices will increase.
  • Where businesses are faced with increased costs they must put their prices up to meet their costs. This is called cost-push inflation.

Inflation is measured in New Zealand by the Consumer Price Index (CPI). This is the official measure of the average price of goods and services purchased by ordinary households. It is measured by government statisticians who take a basket of goods and services and quite literally mark off the current prices of goods and services against their list, adding up the total. This is then compared with the total cost of the same basket in the previous month to work out a percentage change in prices.

Inflation affects people as well as the economy. For older people who rely on their savings to live, high inflation can be devastating. As inflation goes up, the spending power of the savings they're living on will go down unless their savings are earning a return at least as high as the rate of inflation.

Likewise if inflation goes up, but your salary or wages don't, then your relative standard of living goes down.

Inflation can work to your advantage if you have borrowed money. Provided your income goes up with inflation, the relative value of your mortgage or personal debts go down, making it easier to pay them off. But high inflation can go hand in hand with high interest rates. 

The opposite of inflation is deflation – when the general level of prices is falling.

Summary

  • Inflation is simply the increase in price levels over time.
  • Inflation makes the money you earn worth less.
  • Inflation can make paying off debts easier.