You hear the term, you probably listened to some financial guru speak about it, you researched the term, so you have a basic understanding. But how does inflation affect you?
Inflation refers to a situation in which you find that it takes more units of currency to buy goods and services than it took you yesterday or last year to buy the same products and services.
What are the specific effects of inflation?
Why should you be concerned about its spectre haunting the economy?
Inflation Begins with Money Losing Value
To understand the effects of inflation consider this; a J$100 bill in 2000 cannot buy the same things today. A patty cost J$30 or J$40, but now the same patty cost J$150.
The same situation applies to bread, gas or everything you use on a regular basis. The significant effect of inflation is that a nation’s nominal currency loses value – it takes more Dollars, or Pounds Sterling, or Swiss Francs, to buy the same quantity of goods.
The obvious effect of this is that inflation makes it more difficult for people to afford the necessities of life if their labour is not able to keep pace with the inflation rate. This results in families struggling to keep up with the price of everything from cornflakes to college tuition.
Inflation Transfers Money From Savers and Investors to Debtors
Moving beyond the underlying effects of inflation, you come to realise there are two other significant effects of inflation.
The effect of inflation on savers and investors is that they lose purchasing power. Whether you’ve buried your money in a coffee can in the backyard or it’s sitting in the safest bank in the world, it is becoming less valuable with the passage of time. This can create an incentive to spend money or, under the wrong conditions, a disincentive to invest money in things that would otherwise be good for civilisation in the long-run.
The effect of inflation on debtors is positive because debtors can pay their debts with money that is less valuable. If you owed $100,000 at 5 percent interest, but inflation suddenly spiked to 20 percent per year, you are effectively watching 15 percent of your debt get paid off each year, entirely free of cost. At some point, you’d be able to get a minimum wage job for $100 per hour and obliterate your debt.
Put more bluntly, the net effect of inflation is that it serves to transfer money from savers and investors to debtors. It punishes those who postponed their enjoyment and invested in building roads, schools, factories, and businesses and gives their reward to those who are in debt. It is a severe moral injustice, mostly caused by governments printing money — or, these days, making electronic entries — to cover expenses that cannot be paid out of the general treasury revenue.
Think about it.