Inflation.
It's a word that has seemingly entered our every day vocabulary.
But not because the balloons need pumping up, or the tyres need some tlc.
Nope.
Instead, it's inflation in the economic sense that has dominated the headlines, dinner party conversations and day to day small talk.
"You know that food shop cost a fortune!" "Fuel costs how much per litre?!" "I paid £8 for that glass of wine **gulp**" "Love, our mortgage has doubled in price."
Every element of our lives is being impacted. But how much do you really know about inflation?
Don't panic; I got you. Sit back, feet up and grab your cuppa. Let's demystify inflation.
What does "Inflation" even mean?
Definition: Inflation is the percentage change in the value of the Wholesale Price Index (WPI) on a year-on year basis. It effectively measures the change in the prices of a basket of goods and services in a year.
That's a dictionary definition.
Inflation is the increase in the general price level of goods and services over a period of time. Essentially, it means the your money doesn't have the same buying power as it did before.
Say you wanted some lego (go big...imagine the lego death star) and you pop it in your amazon shopping basket today. You leave it sit for a few months whilst you save your £400 to buy it. When you finally have your £400, you head back to your amazon basket ready to check out - prime delivery and all. When you get there, the price of your death star has risen by another £50. And just like that, you can no longer afford your death star.
Your money suddenly doesn't have the purchasing power it once did.
Getting a real understanding of inflation
Whilst it's easy enough to track the changes in the price of your lego death star, or even another couple of products, as people, we require a range of products and services to live our lives comfortably. Things like food, fuel, gas, electricity, amongst others.
The inflation we see on the news and hear about day to day, is attempting to measure the overall impact of the changes in pricing for a range of products and services. Then instead of multiple percentages being used per good or service, there is one single percentage used to measure almost everything over a period of time.
Unfortunately, when the buying power of cold hard cash is diminished, that impacts the cost of living for everyone which then leads on to a slow down in economic growth. With that slow down in economic growth, products and services become harder to find, making their prices rise (supply and demand) and ultimately giving the money less buying power all over again.
At the same time, when wages increase, or when borrowing is easier, more money is available, people have more available to spend, this also impacts inflation for the worse. Where more money is, the value of the money is less. (Supply and demand).
It appears no win. A perpetual state of misery.
So what now?
Let's talk base rates
Heard of the Bank of England Base Rate? Most probably. If you have had a conversation with your mortgage broker, turned on the news or taken a loan or credit card recently, THIS is a key piece of information.
In the United Kingdom, the official bank rate is the rate that the Bank of England charges banks and financial institutions for loans with a maturity of 1 day. It is the British Government's key interest rate for enacting monetary policy. As it stands, that rate sits at 5%.
What on earth does that have to do with inflation?
Everything.
It's common thought amongst economists that sustained inflation is because of a nations money supply growth outpacing its economic growth. Sustained inflation would be really bad.
The monetary authority - in the UK, the Bank of England - takes the necessary steps to manage the money supply and credit to keep inflation within permissible limits and keep the economy running smoothly. They do this by increasing interest rates meaning borrowing costs more but savings rates are higher. When the interest rate rises, it should encourage each of us to save more money, causing less spending, meaning less demand for certain goods and services.
And the result?
Prices fall. Inflation falls.
And today it did just that. Surprisingly. After 13 rises in the base rate (it was 0.1% back in December 21 hitting 8.7% in May (I shall allow a moment for you to pick you jaw up off the floor) the surprise drop in inflation to 7.9% last month means that a 14th rise is much less likely.
And that my fellow intrepid junior economists is inflation.
Get it all? Save this article to refer back to when you hear inflation on the news again.
Speak soon!
Jess x
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