Do you know what is common between you and the RBI?
Both deal with inflation daily. Both want it to go down. But the power of inflation is so high that RBI struggles and people suffer.
What actually the inflation is? You hear about the inflation daily but many of you neither know the real meaning of the word inflation nor know how it impacts your pockets, your today and your retirement.
The funny way to put it is: “Law of inflation: whatever goes up will go up some more”
Today we will deal with it to make you decode perhaps the most fearful economic word Inflation.
What is Inflation?
The simple definition of the word inflation is – A long-term increase in prices of goods and services and fall in the purchasing power of the money.
The rate of Inflation is the rate at which the prices increase. For example, if the price of Apple was Rs. 100 per kilo a year ago, and if it becomes Rs. 105 per kilo today, the rate of inflation is 5%.
The Government measures it at a wholesale and retail level, with the basket of products but the principle is the same.
“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” Sam Ewing
Inflation is not a major cause of concern but it is the rate of inflation which could be catastrophic.
What Causes Inflation?
- Price increase when too much money chases fewer goods/services. When the money supply is not matched with the supply of goods, prices go up. More demand, less supply.
- Price increase when the Govt. prints more currency to manage its expenditure. More circulation of money chases the same amount of goods increase the price.
- Heavy Govt borrowings make them pay a high-interest cost. To generate high-interest expenditure the Govt either borrows or increase taxes or print more currency. In all the scenarios, inflation increases.
- If they borrow more, interest cost will increase for the future.
- If they increase taxes, the cost of the businesses goes up and they will increase the prices.
- If they print more currency, the money supply will push prices further.
- When the economy is doing good and salary and wages are on the rise, demand pool will increase the prices. This may be for a shorter period. An increase in demand will enable an increase in investment and more capacity will be put up by the businesses.
- Since India is dependent on imports of Oil, exchange rate change is also a major cause of inflation. Indian rupee to a US dollar rate impacts the rate of inflation in India. When the rupee becomes weaker than the dollar, the price of Oil increases. Oil price impacts various aspects of the economy. This can have a cascading effect on the prices.
In fact, the rate of inflation plays a crucial role in determining the value of the currency. Lower the inflation enhances the value of the currency.
Handpicked related post: The dangers of remaining financially illiterate for young educated Indians
How Inflation Impacts you?
Inflation impacts you in several ways. Increase in inflation i.e. increase in prices of goods and services you consume affects your pocket adversely. This is an immediate effect. However, the continued increase in inflation adversely affects your retirement plans.
The money you save today may not be sufficient for you to sustain the same standard of living in the future.
Suppose your monthly expenses today is Rs. 50,000/-. You will need more money; say after 30 years when you retire to sustain the same standard of living. You need much more money. We all have heard the stories of low prices years ago from our parents.
Considering the inflation rate of say 5% p.a., your Rs.50,000/- today will become Rs.2.20 lakhs after 30 years. You will need more than rupees two lakhs to sustain the same standard of living.
This means you will need a retirement corpus of minimum Rs. 325 Lakhs. At 8% return, this corpus will generate a monthly income of about Rs.2.20 Lakhs. This will change if the rate of interest changes.
“Inflation is taxation without legislation.” Milton Friedman
If your savings earn less than the rate of annual inflation, you are in fact losing money. The goal should be to earn more than the rate of inflation and that too with safety.
Inflation impacts your present, it impacts your future too. It makes you work hard to sustain the same level of living. It makes you work for more years. It prolongs your retirement. It makes you defer pursuing your dreams.
This is the effect of Inflation in your life. Like it or no, but you can’t ignore it.