What about? What is inflation and what does it mean for your wallet?

Seemingly simple questions are often the hardest to answer. How are you? we try every week to find the answer to such questions. This time: What is inflation and what does it mean for your wallet?

High inflation

You have probably noticed all the reports of high inflation. It is currently around 6.4 percent. According to experts, it is quite high and it does not look like this percentage will drop significantly in the coming period. What exactly is inflation? How does it occur? Why is high inflation seen as something negative? And what does that ultimately mean for your wallet?

Price increase

We are talking about inflation when the general price of goods and services rises. Such a price increase can have various causes. In the 1970s, for example, inflation is high because the oil-producing countries raise prices a lot, explains Harald Benink, professor of banking and finance at Tilburg University. OneToday Radio on NPO Radio 1. Already now the rise in inflation is partly due to high energy prices.

How is it calculated?

The inflation level is not something that has just come out of the blue. To reach the correct conclusion, we look at the prices of certain goods and services that Dutch households use or buy. The European Central Bank provides a number of examples on its own website:

  • daily groceries (eg food, newspapers and petrol)
  • durable consumer goods (eg clothes, computers and washing machines)
  • services (eg hairdressers, insurance and rental properties)

The prices of these types of products and services are measured and compared with the prices in the same period last year. The difference in price is then the inflation rate. Suppose: In 2019 we pay 100 euros for a range of goods, but in 2020 all this will cost 102.90. Then inflation is 2.9 percent.
It is not the case that all products and services are weighted equally when determining inflation. Things and services that we spend more money on have a greater impact than, for example, a carton of sugar.

Same money, worth less

Inflation not only indicates the state of prices, but also has a direct effect on the purchasing power and value of money. After all, you need to have more money to buy the same thing, something you can feel in your wallet.

Many consumers will see this as the most negative consequence of high inflation because no one wants to be left with less at the bottom. However, that is by no means the only negative. It is also not good for the economy, because high inflation can ultimately cause a great deal of uncertainty among citizens and entrepreneurs. It becomes more difficult to assess how much is left to save and invest, which makes it safer to keep a close eye on your wallet. It is not conducive to economic growth.

The role of the ECB

To prevent high inflation from creating uncertainty, the European Central Bank (EBC) is trying to keep prices stable. That is the main task of this body. To achieve this, the EBC is aiming for 2 percent inflation. That way, prices do not rise too fast and there is enough room for economic growth. The percentage is now significantly higher than the 2 percent. How could that have happened? Maybe a miscalculation, but it can not be said with certainty. In any case, the ECB does not necessarily see such an increase in inflation coming, said ECB President Christine Lagarde during a press conference on 3 February 2022.

Also read: Why do not we get interest on our savings?

Interest rate rise

To normalize the situation, the ECB can use so-called monetary instruments. Raising bank interest rates is one such tool as the ECB decides official interest rates in the euro area. Higher interest rates can slow down inflation because it becomes less attractive to borrow money. Interest rates are now very low because the ECB some time ago determined that inflation would fall below 2 percent if interest rates were not lowered. Now it seems like it’s time for a rate hike, but whether that actually happens remains to be seen.

(Source: ECB, DNB, Trouw, NRC, NOS)

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