What Is Inflation?

Inflation is described as the gradual increase in prices and decline in purchasing power of money over time. While the short-term effects of inflation may appear negligible, over a long period, inflation reduces how much your money is worth.

Read on to learn about inflation and how you can protect the value of your savings.

INFLATION EXPLAINED

Inflation refers to the decrease in purchasing power when prices of goods and services increase.

The inflation rate is the rate at which the value of money declines as prices for things such as food, clothing, consumer staples, transport, and utilities increase.

For example, a US coffee cup cost around $0.75 in 1990. In 2010, a tall cup of Starbucks coffee cost around $4. If you saved a $10 bill from 1990, you would buy fewer cups of coffee two decades later.

However, it would help if you did not think of inflation as simply higher prices for a single item or service. Inflation is the holistic rise in prices across a sector of industry, such as the manufacturing or food industry, and ultimately a nation’s entire economy.

On a macro-level, high inflation and high cost of living are the most common causes of the deceleration of economic growth. Economists argue that prolonged inflation happens when a country’s monetary supply far outpaces the economic output.

To neutralize this, central banks have long put measures in place to manage the supply of currency and regulate financial markets to bring inflation under control.

However, as we have witnessed in the past two years, excess money printing leads to an increase in inflation. That’s exactly what we are experiencing now.

HOW INFLATION IS MEASURED

Inflation is primarily measured by three main indices, the consumer price index (CPI), the wholesale price index (WPI), and the producer price index (PPI).

While the names of inflation indexes vary from country to country, the methodology used to calculate inflation is more or less the same everywhere.

Since no index can capture the full range of price changes in an economy, multiple price indexes are used to predict the inflation rate accurately.

That being said, the basic formula to calculate the inflation rate is:

Inflation rate = (Final CPI Index Value/Initial CPI Value) x 100

HOW INFLATION ERODES THE VALUE OF THE MONEY IN YOUR BANK ACCOUNT

Inflation doesn’t just affect your expenses. It also impacts your savings.

The value of your savings declines as the purchasing power of money falls.

For example, if you save money in your bank account that pays you 1% interest, but the inflation rate is 5%, the money in your account loses 4% in value. So the item(s) you planned to purchase will most likely become more expensive.

If you are a retiree on a fixed pension, a high inflation rate will erode your pension’s purchasing power, negatively affecting your standard of living.

WHY IS BITCOIN CONSIDERED A HEDGE AGAINST INFLATION?

Out of bitcoin’s total supply of 21 million coins, around 19 million have already been mined. The remaining coins are entering circulation at an increasingly slower rate. Bitcoin is considered a hedge against inflation due to its disinflationary characteristics.

Existing holders are incentivized to hold onto their bitcoin as increasing demand is met with a limited supply, resulting in a disinflationary scenario.

Now compare this to fiat money, where governments can increase the money circulation by printing more money, which leads to a decrease in purchasing power and an increase in inflation.

This article was originally published on relai.app

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