The meaning of inflation
Inflation is nothing more than a general and lasting rise in the price level.
Accordingly, we cannot talk about inflation when the price of a few product has risen or there has been only a temporary rise. Inflation is a process, the rate of which is determined as a percentage of the previous year’s price level. The consumer price index is used for this. This is recorded by the CSO in Hungary.
Then you will experience a decrease in the purchasing power of the same amount of money, only sometimes the process is either slow or already natural for you, so it doesn’t even show up. The decrease in purchase value is most visible in the items you buy regularly. Play a little time traveler and see how much you could buy from your salary today if you could travel back in time. You can find the compilation on the CSO website.
Being a virtually rich person from your current salary doesn’t mean you are doing better now, but that your money worth more in the past.
It’s even called money deterioration, and since money is everywhere, inflation affects every country, only to varying degrees.
Causes of inflation
There are many reasons for inflation, even mutually reinforcing, and now let’s look at the most important ones.
In addition to the cost of production, the price of a product is basically determined by the demand for the product and the supply that serves it. If I want to present it, it looks like this:
The higher the price, the larger the quantity offered by the seller, but the smaller the quantity bought by the buyer.
Rising prices, and with them inflation, can start on the side of both producers and consumers.
Supply – side inflation
If the cost of production generally increases, companies will either incorporate it into their prices or not produce it. Such an increase could be, for example, an increase in labor costs, but even a significant increase in the price of a raw material.
Demand – side inflation
If the consumer has easier access to money, he lives off for some of it. Then for a while you can afford to buy more products or higher quality even at a higher price.
This can happen during a wage increase or when you get a loan at a low interest rate. Because you can borrow at a lower interest rate, banks also have less risk, making it easier to qualify.
Completing the drawing above, it could be represented as follows:
It is clear that if the consumer is willing to pay more for something and even buys more, the sellers will adjust the offer accordingly. They may produce more, but the higher price is guaranteed. (That’s why you don’t have to address them, you would do the same )
Wage inflation is present on both the demand and supply sides and creates a price-wage spiral. If wages rise, the consumer can afford to buy a little more or more expensive. At the same time, labor costs have risen.
Because this increased cost is incorporated into sales prices, the worker will not receive a larger amount of product from his increased wage after a period of time.
If the majority of sellers expect inflation, they will incorporate it into their prices and so it will actually be created. Whether or not it was created without it.
Countries are economically interdependent, which is why they trade with each other. Countries that use different currencies sell the same product at different prices.
The simplest example of this is Hungary and the euro area. If a product was imported at an exchange rate of HUF 300 / EUR, for which the manufacturer requested EUR 1.000 together with delivery, the domestic wholesale price was HUF 300,000. If the euro moves to the level of 350 HUF / euro, the manufacturer will ask for 350.000 forints for the same product in order to receive the 1.000 euros needed for it.
Because each economy is interconnected on multiple threads, it can represent a significant volume.
The amount of money present in the economy
The amount of money is indirectly influenced by the government and directly by the central bank. This can be achieved, for example, by changing the base rate or printing new money.
You have no control over the amount of money present in the economy, at least it is advisable to leave this to the state according to the Criminal Code.
If the base rate is raised, it will be harder to borrow, but the willingness to save will increase. This will put less money into the economy and so they can cool it down a bit.
However, the government does not fully aim to eliminate inflation, as the general government deficit is partly covered by government securities. Since they then have to pay interest, it is useful to be numerically capable of doing so. The businesses solve that by produce and make value. The state often does not have the option to do so, so you can choose between going bankrupt or infiltrating the debt. Typically, the latter tends to happen, which is why the inflation recorded by the CSO and the interest rate curve of government securities are so similar.
The rate of inflation
Every economy needs a minimum level of inflation, but it is important how much level we are talking about.
Depending on its extent, it can be creeping, galloping, or hyperinflation.
The price level is growing by only a few% a year. Then you have the optimal effect of still driving the economy but not overburdening it.
The dangers of creeping inflation
Danger of deflation
With creeping inflation, there is a danger of it turning into deflation, which is detrimental to the economy.
Even if there is no deflation but the inflation rate is too low, the government can be trapped in liquidity. Interest on government securities is covered by tax revenue, which they can raise due to inflation without collapsing the economy. If tax revenue does not increase enough, you may not be able to pay the interest earned on government securities that have already been issued.
That is why the central bank and the government are definitely trying to maintain a healthy level, sometimes with economic stimulus packages and sometimes by cooling the economy.
In this case, the rise in the price level is already in double digits. A stable economy with reserves can perform well even in this case.
Due to the rapid devaluation of money, people keep little cash. To protect their money from losing its value, they either choose a foreign currency or keep their assets in some kind of investment, possibly a durable consumer good.
With hyperinflation, no economy can keep up anymore, in which case the rate of money deterioration can exceed 100% per month.
This also happened with the hungarian pengő in 1946, there were many mutually reinforcing reasons for hyperinflation at that time.
That is why it was necessary not only to switch to the forint, after all, only its name would have changed, but it had to be placed on completely different foundations. With the introduction of the forint, the availability of money was practically artificially limited, thus preserving its purchasing power. This was made possible by the coordinated work of the government and the central bank.
What effect does inflation have on economic agents?
Like everything, inflation has winners and losers. So if you watch carefully, you have the opportunity to decide which group do you want to belong to.
- Borrowers: the real value of capital is worsened by inflation, making it somewhat easier to repay (this is exactly what you saw in the section on government securities above)
- Investors: as they do not keep their assets in cash, they are expected to keep at least the purchase value when converting the investment to cash
- Lenders: since they only get their money back later, they have to reckon with the fact that the purchase value of the amount deteriorates in the meantime.
- Those who rely solely on their wages: their purchasing power can only grow temporarily, the effect of wage increases will melt in the long run.
- Those who only save in cash or bank deposits. Then the deterioration of money degrades the purchase value of their money
- Retirees: their pensions are only adjusted for inflation with a significant time lag. That is why it is necessary for you to plan your pension
If you want to be one of the winners, plan ahead and choose a device that supports this.
Protecting against inflation
The easiest way to protect yourself against inflation is to not keep all your money in cash. Choose an investment that also fits your own risk appetite and can produce above the level of inflation. If you request, we can help you determine and select this. Contact us to make an appointment.
If you are searching on your own, you can still choose from many options. Examples of suitable tools are:
- bond funds and equity funds, as well as more complex investment funds
- some index tracking funds
- silver, gold, precious metals, industrial metals
- although the property is capital intensive and requires a lot of expertise as well, you can get good results with it. If you do not want to deal with real estate, you are only sking for a share of the profits, you can also choose a real estate fund.
However, you may not be able to use it for this purpose:
This is because they typically perform below inflation.
Investments are suitable for adapting your portfolio to your different life situations, thereby increasing your own wealth.
- How do you protect your existing financial assets against inflation?
- How do you prepare for your existing reserves to be sufficient in the future?
- What level of inflation do you think is still driving the economy but acceptable to most of the population?
If you would like to protect yourself against inflation, contact us to arrange a date for this.