👋🏼 everyone,
Jason here! I started this weekly newsletter because although our lives are dominated by our finances, many of us don't understand the financial world very well. This means we often miss out on opportunities or make poor financial decisions.
Over ten years ago, I turned down an opportunity to work for what would become a hugely successful start-up because, to be honest, I didn't understand the compensation package I was being offered. No one had ever explained to me how stock options worked; the pros, cons and everything in between. Terms like 'vesting period', 'cliff' and 'hurdle' meant little to nothing to me. It wasn't until a few years later that I realised my mistake and made it my mission to ensure it never happened again.
The world of finance can be riddled with jargon, can be deeply alienating and can make a lot of us want to run away from it. But don't - run towards it.
Each week we're going to take a financial concept and break it down into plain English. And we're going to do our best to do it in a way that's engaging and fun to read!
Let's start with something that's got everyone talking.
What's inflation (practically)?
(Quickly) Explained...💬
What is it?
Inflation is the term that's used to describe rising prices. How quickly prices go up is called the rate of inflation.
🚨Why should it matter to me? 🚨
It (should) matter to you because it affects your cost of living. As prices go up, your money buys less, which means that you need more money to maintain your standard of living. This can make it harder for you to afford the things you need and want, like housing, food, clothing, transportation, and entertainment.
Alongside this, inflation can also impact savings and investments. If the interest rate on your savings account does not keep up with inflation, the value of your savings will decrease in over time in real terms.
How and who calculates it?
OK, so I mentioned above that inflation is when prices go up and the value of money decreased over time. To find out how much prices go up, experts* use something called the consumer price index (CPI). They look at the average cost of a basket of things that people usually buy, like food, housing, and transportation. They then figure out how much the cost of this basket has gone up over a certain period of time, like a month or a year.
*Experts - so they'll have different names depending on the region e.g. in the US it's the Bureau of Labor Statistic and in the UK it's the Office for National Statistics (ONS)
What factors influence inflation?
Honestly, this is the tricky part as frankly there are many things that can make prices go up. Here's a sprinkling of reasons what impact prices:
When people have more money to spend: When people have more money to spend, they might buy more things, which can make prices go up.
What the central bank does: The people who control the amount of money in the country can affect how much things cost.
When there are problems with getting things: If there are problems with getting the things we buy, like crops being damaged or transportation problems, it can make those things more expensive.
Again, these are just a few examples, but hopefully give a flavour of what can influence prices.
Common effects and implications of inflation so you know what could happen
Firstly, it may come as a shock to some that sometimes inflation can be a good thing. Why? Well because in some case moderate inflation can be a sign of a growing economy, as increased demand for goods and services can drive up prices. There's a few other reasons it can be good too, like reducing unemployment. If there's an increased demand for goods and services then businesses will need to hire more people to meet those needs.
But there's of course the downsides too - the most obvious and arguably most painful for us all is that the cost to live becomes more expensive. When wages do not keep up with inflation, things can become bleak. Also to combat inflation (more on this below) central banks often increase interest rates, which can make it more expensive for people and businesses to borrow money i.e. higher repayment amounts.
What are solutions to inflation?
Context surrounding the increase in inflation is key e.g. if it's war i.e. disrupting the flow of goods, which in turn is making those goods scarce and more expensive, then that's a very specific challenge. But in general there's a broad range of options that governments have, such as:
Increase the interest rates to make borrowing more expensive, which can in turn slow down spending and curb inflation
Increasing taxes - if individuals and businesses are paying more in taxes, they have less disposable income, which will mean they're also able to spend less on goods and services which can help stop steep increases in inflations as companies are less likely to raise prices is demand is reducing
Increase the amount of competition for goods and services e.g. if a government started to support and encourage more international trade then that would mean we have more of those goods and services in circulation and that in turn would mean companies are less likely to increase prices (as they might not get the customer vs cheaper competitor)
When reading through these reasons, you might hear yourself saying things like "but if we raise taxes then doesn't that also make businesses more vulnerable i.e. more payouts" - the answer is yes, so the whole thing is one big balancing and juggling act as there's trade-offs to each measure taken to reduce inflation.
Inflation...in 01:33 mins
Tools and tips
I love this simple tool (myinflationtool) which shows you what have been the key contributors to inflation and also let's you see historical inflation data
And this inflation calculator from the Bank of England let's you take a trip down memory lane to see what things cost in the past would equate to in today's terms:
Fun Fact
In 1974, President Ford declared inflation “public enemy number one” and urged the public to wear WIN pins, or “Whip Inflation Now” pins. At the time, inflation was around 7%. The pins were immediately ridiculed and even worn upside down to say “NIW,” or “Need Immediate Money”
Thanks for reading and I really hope you learnt something from this - always love to hear feedback, so just hit the reply button to share your thoughts!
Inflation - what's it all about?
Thank you ...Great newsletter !