Everyone has of course heard the term INFLATION so many times that the term itself is embedded in your brain. And many shout out too often… “That's because of inflation”. But today, let's take a quick look at what Inflation is exactly, and how it can sharpen your financial focus?
What is inflation?
Inflation is nothing more than an increase in the price level in the economy. The price of goods and services is often somewhat stable, but nothing is 100% certain. This means that there can always be movement, and we see that every day! Price swings are the order of the day, but at the time of writing we are in a wave of ups and downs. If you buy 1 whole loaf of bread at the supermarket today for your one dollar or euro and tomorrow suddenly only half a loaf of bread for that money, then there is inflation.
What you should keep in mind is that this is not an offer that is over the next day. It concerns a structural increase in the prices of products, on which we therefore have to spend more money on average in order to continue to live on the same standard. This includes energy contracts, groceries and clothing.
Of course, this is different for everyone, what is purchased. This means that inflation cannot be pinned down to one or a handful of products. When calculating inflation, one looks at all goods and services that are used by the consumer. And very recently it has become clear that we are currently experiencing high inflation. On average, products have become about 2.4% more expensive compared to the same period a year earlier.
House prices are also currently under fire as they rise to record highs. Since this year, the ECB has also included house prices in its inflation calculation. This strategy is part of the ECB's revised policy, which should make it clearer when interest rates will be raised or lowered. This is of course important for consumers, because it has a direct influence on the mortgage interest rate and the level of, for example, pensions.
How does inflation arise?
A general price increase always has a cause. Only that cause is not always the same. Here I discuss four different forms of inflation, two of which are the most obvious: cost inflation and spending inflation.
1. Cost inflation
This is one of the most widely used forms of the economic phenomenon. The rising costs of sellers are passed on in products and services, so that the consumer is presented with a higher bill. This cost increase is currently caused, for example, by rising raw material purchase prices, higher tax rates and strongly fluctuating exchange rates due to the pandemic.
2. Spending inflation
This is directly the second form. When there is scarcity, ie when there is more demand than supply, we speak of spending inflation. Because there is too little supply, while demand does exist or is even growing, companies can raise prices.
3. Imported inflation
If the costs of products rise across the border, entrepreneurs in our country will be billed. Buying more expensive goods from abroad? That means imported inflation!
4. Earnings Inflation
The last form we discuss is earnings inflation. This is when the goods and services become more expensive, but not for economic or social reasons. Prices are raised, with the aim of increasing profits, because that's capitalism.
What are the advantages and disadvantages of inflation?
When there is inflation, the general price level rises. This allows us as consumers to spend less, which means that we experience a declining purchasing power. If you used to do your weekly shopping for €100, and you have now lost €105, you will experience the adverse effects of inflation. In addition, it is often the case that the price level rises faster than income, which can lead to payment problems.
However, there are also people who benefit from inflation. Relatively low inflation, which is below 2%, can be seen as positive. Consumers feel compelled to invest, as it will probably become even more expensive later on.
Borrowing money can also be interesting in times of economical price increases, because this means you pay relatively less interest on the loan amount. As you can see, inflation has many advantages for the functioning of the market, provided it is not too large an increase.
The target groups most affected by inflation are people with a less than average income. Think of flexible employment contracts, social benefits or those who receive a small pension. People who have a fairly unassailable position in working life and who are affiliated with a trade union, experience the disadvantages of inflation less intensely.
How do you protect yourself against price fluctuations?
There is really only one way to protect yourself against a rising price level, and that is to have a good financial policy. By limiting your expenses and maximizing your income, you get the best out of the battle. But hey, of course that applies to almost every situation in life.
Make sure you know which part of your income is spent on what expenses, so that you are always on top of things. Which categories in particular make you money and can you therefore make savings. If there is little to save, it is a good idea to maximize your income. Perhaps even passively through crypto?
How can you maintain your purchasing power?
Here is of course a simple list of saving tips, such as:
- Use a cash book;
- Save on usage by turning off electrical appliances;
- Use less water when showering;
- Save automatically;
- Earn extra with taking on a side gig;
But are those things that everyone already knows? So it's time to look further at other things, such as increasing your income by investing! By investing in the growth of your stock and/or crypto portfolio, you can realize value growth. This allows you to maintain or increase your purchasing power.
And then of course we have arrived at LBI again… Have you already achieved your goal, or would you rather have some more LBIs in your portfolio?
