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Inflation is the general increase in prices within an economy over a certain period of time. When inflation occurs, you can buy less with the same amount of money than before. The purchasing power of money therefore declines.
Inflation affects savings, wages, interest rates and ultimately investments.
Inflation can arise in different ways. When consumers spend more money and demand for products rises faster than supply, companies can increase their prices. This is known as demand driven inflation. Inflation can also occur when companies face higher costs, such as rising wages or more expensive raw materials. To remain profitable, they raise their prices. This is called cost push inflation. A limited level of inflation is considered normal in a healthy and growing economy
Central banks, such as the European Central Bank, aim to keep inflation at a stable level, often around 2% per year. However, excessively high inflation can lead to uncertainty and significant loss of purchasing power, while very low inflation or deflation can slow economic growth..
Short example:
Suppose energy prices rise sharply. A baker then pays more for electricity and for transporting flour. His costs increase, so he raises the price of a loaf of bread from €2.00 to €2.10. Other bakers do the same. Because bread is part of the average price level, prices rise across the economy.
Employees notice that groceries are becoming more expensive and ask for higher wages. If employers increase wages by 3%, their costs also rise. Companies then raise their prices again to offset these higher wage costs. The bread, for example, increases to €2.20. This creates a process in which price increases reinforce one another.
After several years, the same loaf of bread may cost €2.40 instead of €2.00. That represents a 20% increase. Anyone who has not received a higher income during that period will clearly notice that their money has lost value.
Disclaimer: Investing involves risks. Our analysts are not financial advisors. Always consult a professional advisor when making financial decisions. The information and tips provided on this website are based on the personal insights and experience of our analysts and are intended for educational purposes only.
