Inflation is a constant whether we’re on the receiving end of its positives or its negatives — there’s no avoiding it and if we can make it work better for us then that’s a goal we should all be aiming for.
Why does it happen?
Simply put, inflation is the rising cost of products and services. Each year depending on the supply and demand of these products and services those in charge of them decide if there’s enough demand to charge more and make more profit.
Causes of inflation
If the demand of a product or service is rising faster than the ability to supply it then the sellers can raise the price. This is usually the case in growing economies.
If the cost in manufacturing a product rises, for example if the components become more expensive, or wages, taxes, rents or other influencing factors add additional costs to production, then the price to the buyer must be increased to maintain the same profit as before.
The supply of money into the current market will also affect inflation. If the Bank of England introduces more physical money into circulation then it effectively reduces the value of the products and services.
Advantages to inflation
Investors get more for their money
Stocks and shares of investments in commodities are worth more. Selling stock at times like these will create a profit for the investor and in spending it reintroduce money into the economy.
For workers to be able to maintain the same standard of living as prices rise they will also need to gain a boost in their income. This maintains a balance of money in to money out and regulates our spending.
Banks have more capital to utilise
As we deposit our newly increased wages to our bank accounts this gives the banks a bigger pool of money to lend to their customers. This encourages spending and feeding the economy. The additional interest charged to borrowers introduces further additional money to the bank’s pools and continues the cycle.
It’s easier to borrow and costs less
If the banks have more money to lend they can charge less for the facility. If it’s easier for borrowers to obtain money there’s higher chances of them spending and again, feeding the economy.
Avoidance in deflation
Without inflation the costs of products and services becomes lower and this drop in prices creates a hope that future costs will drop even further. Spenders will hold on to their money in hope for even better prices that decreases feeding the economy.
Decreases the value of debt
As inflation raises your income any debt you may already have remains the same, in effect lowering its value giving you more disposable income to insert back into the economy.
Disadvantages to inflation
A high rate of inflation causes investors to take more care with their reduced available funds. This leads to less investment and starving the economy of the capital it requires to operate in a healthy manner.
A decrease in exports
High inflation leads to a much more competitive market. With our products and services becoming more expensive we make fewer exports that lowers the amount of money entering the country from overseas.
Static wage growth
A low rate of inflation can cause a slow down in wage rises and in turn reduces the amount of money fed back into the economy.
Reduces the value of savings
As the value of the pound rises any money you have saved decreases at the same rate. Interest rates on savings accounts will only help to combat this if they are in line with the current rate of inflation.
To restore balance in the economy the Government and Central Banks need to introduce measures to counteract the problems causing the shortfall. These will generally lead to lower levels of demand and often result in recession and unemployment.
Property prices rise
Due to the higher interest rates applied by the banks mortgage rates and property prices will rise and the amount of new or first time buyers in the market will decrease. This causes less spending and again less money fed into the economy.
How to manage inflation
Keep an open mind about savings
It seems negative to say that saving money isn’t always the best thing to do in our current climate. The value of that money is going to drop so unless your bank account offers you an interest rate of around 4 or 5% (and so few do) there’s a good chance that your investment will be worth less at the end of the year than it was at the beginning.
Be aware of rates on long term loans
Depending on how the market is going to affect inflation, loan repayments can change dramatically if interest rates fall during the term of your loan. If you get caught in this situation it could be worth looking into whether or not the terms and conditions of your current loan will allow you to repay it with a cheaper loan from another lender.
Invest in other areas than banks
If you can invest in a market that continues to grow with inflation then this will help combat the poor rates of interest currently given on savings from your bank. An obvious example is property. The value of gold and silver will also rise with inflation.
Look into long-term investments
If investing in a longer-term investment can offer you a larger return on your capital then there’s a higher chance of making a profit instead of just keeping up with inflation after paying the costs of the investment in taxes.
Invest in stocks and shares
Playing the stock market requires specialist knowledge but the returns are often greater than investing in standard methods such as savings accounts, ISAs or similar. A current trend is investing in Bitcoin or cryptocurrencies. This has become a market with a natural rise in growth, making early investors very large sums of money.
Consider sectors where demand will always be high. Investing in resource companies might be a safer bet knowing that traders will always need their product.
Consider a loan
The money you can borrow now will be worth a lot more than when you come to pay it back in two, ten or twenty-years. As long as the interest rates appear to look more favourable than the rise in inflation, especially if you can search out fixed low rate lending, then you could actually be gaining much better value for that money.
And although it’s not the cheeriest thought in this process but if the term is longer than your expected life span then you won’t have to worry about paying off the total loan amount at all!