Inflation – My thoughts on this subject

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Definition

Inflation is the rate at which the level of prices for goods and services increases. Thus contributing to the decrease of your purchasing power.

Inflation – My thoughts

Nowadays there is a growing concern about the rise of the inflation. It increased to a 4-year high of 2 percent (Euro Zone). Normally when this happens, it means that the central bank (ECB), that has a target of maintaining the inflation in 2%, will be pressured to decrease its bond-buying program and increase the interest rate. The problem that I see here, is that core inflation (excludes food and energy prices) remains low and stable in 0,9%.

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Source: EUROSTAT

You can see in this image (red line) that the main contributor to this increase appears to be the energy prices. Also, there is a contribution from “food, alcohol & tobacco”. Energy prices have a lot of volatility. I believe that only when core inflation increases to 2% will the central bank (ECB) review (and change) its policies.

An important issue is the gap between different countries within the euro area. It will be interesting to learn how the ECB will deal with this subject, especially if the gap between those countries increases.
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Why is this important?

I would say that there are a lot of repercussions of higher prices. For example, if I depend on energy (oil, gas,etc.), an increase of these prices, will have important effects and I should prepare for it.

Another important aspect is how we think about investments and returns. A return (R) of 5% with 0% inflation (I) could be decent. If it is 3% with inflation of 5%, it’s not decent. Because in “real terms” your money will lose “purchasing power”. In the end, I want my investments to have a real positive rate of return. The rate of return above the inflation.
So in the last example (R=3%; I=5%), the real return is -2%. It means that your money decreased in purchasing power by 2%.

Remember these are simplified explanations only to learn the concept.
Going forward I will talk about strategies to minimize the effect in our money.

If you agree/disagree, or wish to add something to this thoughts, please feel free to comment.
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2 Comments on "Inflation – My thoughts on this subject"

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SMM
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Inflation is a scary topic and I’m not sure we are all fully recovered yet from the 2008 recession to embrace it. It’s clear that the stock market is continuing to rise, housing prices as well, but we should tread carefully. I’ll let you know when my gallon of milk hits $5!

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