What is inflation? Our expert explains in simple terms

Pantry staples, petrol and rent prices keep rising. The cause is inflation but you’re not alone if you don’t know exactly what that means and why it won’t stop already. We asked Belinda Allen, a CommBank economist, to break it down and explain inflation.

  • Simply put, inflation is when prices increase more rapidly than usual.
  • Inflation reduces purchasing power: prices increase, and the value of money decreases.
  • When household demand for goods increases, this contributes to inflation. Supply chain issues, high employment and low interest rates are key factors.
  • The Reserve Bank of Australia is increasing interest rates to reduce spending and lower inflation.
  • Inflation is expected to normalise by the end of 2024.

Inflation means your purchasing power decreases: you pay more and get less

“Let’s take the ice-cream your kids might buy on the way home from school. Normally they cost $4 each but more recently the price has gone up to $5 for the same ice-cream. That’s inflation – when you pay more for the exact same item. It means your dollars and cents don’t go as far today as they did yesterday.”

During inflation prices increase more quickly than usual

“Inflation is a normal part of the economic cycle – prices are supposed to rise slowly over time. But it’s usually so gradual we don’t really feel it. For a healthy economy, the Reserve Bank of Australia [RBA] – tasked with ensuring our economy prospers through setting interest rates – wants an inflation rate of 2 to 3 per cent. It was hovering there for several years before the pandemic but right now, it’s at 7 per cent.

That’s influenced by a couple of things: some prices are rising because supply is constrained, from things like the pandemic, natural disasters and political unrest. We’ve also had several years of high employment, low interest rates and a lot of government support.

This means household demand for goods and services is up, which causes prices to increase, too.”

The question is, when will inflation go down?

“To get it back down to 2 to 3 per cent, the RBA has been increasing interest rates. They do that so Australians have to devote more money to their mortgages and reduce the amount they’re spending.

People with variable mortgages felt this straight away and lowered their spending. Hikes in rent, utilities and groceries have reduced household spending, too. But some people, like those with fixed mortgages, haven’t felt the impact of higher mortgage payments yet so they’re continuing to spend. That’s why the RBA has lifted interest rates over the past year.

The good news is that we believe inflation has peaked and will likely be back to normal by the end of 2024. When that happens, some prices will stay high but buying power will increase again as interest rates should be lower. Some costs, like certain pantry staples and fuel, may also decline again. And wages – where growth has been low for years – are rising and should outpace inflation in 2024.”

Learn more with these guides from the Reserve Bank of Australia

This article was originally published in Brighter magazine

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