Inflation has been a hot topic in the news recently, with reports highlighting that it is now dropping. But what exactly is inflation, and what does it mean when we hear that inflation is falling?
What is inflation?
Inflation is a measure of the rate of increase of prices over a given time, which means the purchasing power of our money decreases.
If prices increase, then the value of our money has decreased. Good luck trying to buy a Freddo bar for 10p, which is what it cost in 2000!
How is inflation measured?
In the UK, inflation is measured by CPI (Consumer Price Index), this represents an ‘imaginary shopping basket’ of about 700 goods/services each month. Most recent items have included air fryers, crumpets and jam. Items are updated to include recent purchasing habits.
For example, say if a jar of jam cost £1.00 this time last year, and is now £1.05, it would mean a 5% rise in inflation for that item.
What is the current inflation?
Inflation in the UK currently stands at 3.1%, down from a high of 11.1% in October 2022.
However, it’s crucial to understand that a decrease in inflation doesn’t mean a decrease in prices. It just means they are rising slower, at 3.1% compared to 11.1%.
An inflation rate of 3.1% means that prices are 3.1% higher than they were this time last year.
Pros and cons of inflation
Pros
- Economic growth: Mild inflation can stimulate economic activity. A small level of inflation pushes people to buy sooner, rather than wait for prices to drop, if there is more demand for goods/services this also means more production/jobs to meet demand, which stimulates and grows the economy.
- Debt reduction: It can reduce debt, mortgages or loans for example, as the value of that debt decreases.
- Wage increases: Small levels of inflation can also allow for wage increases.
Cons
- Declining real income: On the other hand, high inflation is a real problem. This can cause declining incomes if wages do not keep up with rising prices.
- Impact on savings: It can also affect savings as the purchasing power of the money is falling, and people will have less money to save with the increase in the price of purchases.
How is inflation kept stable?
The Bank of England (BoE) aims to maintain an inflation target of 2% per year.
They use interest rates as a primary tool. If interest rates rise, which they have done over the last few years, people tend not to borrow and save instead, this means they end up spending less also.
If there is less spending, there is less demand which slows price increases and hence, inflation.
Understanding inflation and how it affects our daily lives can be challenging amidst our busy routines. Hopefully, this explanation has answered any questions you may have had about inflation and its implications.