How does inflation affect you
Don't worry about the inflation figure! It doesn't matter.
You're probably thinking I've gone mad, but read on before you judge me harshly.
Let us define the inflation figure as simply as possible. In the UK the Office for National Statistics (ONS) has put together an average basket of 100 items sold in the UK economy. For example, it includes the average price to fill up a car with a tank of petrol. It also includes the average price of a bottle of wine and so on and so forth. This basket of goods is supposed to representative of what the average consumer spends their money on in the year. The ONS then measures how the prices of those goods vary from one period to the next (a period could be a month or a quarter). The average of this variation across the whole basket of goods is the inflation figure. Currently it stands at 2.8%.
Why you shouldn't worry about the headline inflation figure
The inflation figure should only matter to you if that is the exact basket of good that you buy. Clearly the vast majority of people do not. It may be that the particular brand of beans (let us call it brand B) that you buy has not increased in price during that month. So the knowledge that brand A beans has gone up in price should be meaningless to you.
Furthermore, the inflation figure ignores the substitution effect of prices. It is not the case that if the inflation figure stands at 2.8% that our buying power has decreased by that much. Consumers have the power to increase their spending power by substituting to cheaper goods.
We have now dispelled the myth that inflation eats away your spending power, but what about the idea that it eats away at your savings?
Inflation, destroyer of the savings of the nation?
Part of the reason that people worry about inflation is that it destroys the real value of your savings over time. This is why many savers are conscious that the rate of return needs to beat inflation. This is particularly poignant in this current period of historically low interest rates. There has been much talk about how the Bank of England and the Government are punishing savers for the overspending habits of the borrowers, as low rates, coupled with inflation means that savers lose money in real terms.
Contrary to popular opinion, I don't have a big issue with inflation being slightly above savings rates. It all depends what your plans are for your savings. For example, if you're saving to put a deposit on a house then the increasing price of baked beans is irrelevant. The only prices that should concern you are house prices. The very least that you require is that your savings grow in line with house prices.
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