What is inflation? What can I do about it?

Inflation is simply an ugly fact of life. No matter what you do, no matter where you are, it’s a simple reality that you’ll have to deal with in Canada. But what exactly is inflation? It’s often a topic that comes up but few people actually understand how inflation affects them. In this article we will be talking about the various aspects of inflation: What it is, what causes it, how it affects us, and most importantly, what can we do about it?

The definition of inflation

Inflation is defined as “the rate at which the general level of prices for goods and services is rising, and, consequently, the purchasing power of currency is falling”. The definition seems a bit complicated, but in essence, it means that the value of money is generally decreasing over time.

For example, a dozen eggs at the grocery store today might cost $3. However, 10 years ago they might have only cost $2.50, and 10 years later from now they might cost $3.50. Your money is worth less and less as time goes on.

What causes inflation

Inflation is caused by a variety of factors. However, the most frequent cause of inflation is simply a growing economy. As a country grows, so does the number of people, and so does the supply of money. This will naturally cause some inflation within the economy.

Sometimes, for different reasons, countries might decide to print a lot of currency, which causes something called “hyperinflation”. The most recent example of this was about 10 years ago, when Zimbabwe’s currency became so low in value that a carton of eggs cost a few hundred billion Zimbabwe dollars.

Inflation rate from 2012 to 2022 (compared to the previous year)

How does inflation affect us?

Inflation affects us mainly through the fact that our money is essentially losing value every year. If there is a 2% annual inflation rate, that means the money in your chequing account is losing 2% in purchasing value every single year. It also means that the amount you think you have saved, or are saving for retirement, isn’t as much as you think it is! Let’s look at an example:

Suppose you want to live a lifestyle that requires $50,000 a year, and you want to live like this in retirement. If we use an inflation rate of 2%, that means if you retire in 30 years, you’ll actually need around $90,000 a year to maintain the same lifestyle that $50,000 provides you today!

What can we do about inflation

Unfortunately, there’s not much we can do to control inflation itself, as it is largely determined by the governments fiscal and monetary policies. It’s simply something that we will have to deal with. How do we deal with it? The most important thing is to make your money work for you. Assuming the inflation rate is 2%, and you just hid your money under your mattress, it would lose 2% in value every year. However, if you put that money into a savings account earning 1% interest, you would only lose 2%-1% = 1% every year.

You can probably see where this is going. If you invest your money, and earn a modest 5%, you will actually be gaining 3% in value every year. The worst thing you could do is keep your money as cash under your mattress. From now on, make sure you take care of your own financial plan and take into account the effects of inflation!