What is inflation? How does it affect us?
Inflation occurs when there is a steady and broad increase in prices over a certain period of time. This results in our money gradually losing value over time. In other words, we can buy fewer goods and services for €1 today than we could yesterday.
Inflation is measured via a consumer price index, which is constructed by calculating the change in the price of the “consumption basket”, i.e. the goods and services that households typically consume.
In the euro area we measure inflation via the harmonised index of consumer prices (HICP). All euro area countries use the same methodology (hence the “harmonised”), so that we can compare inflation across the countries.
What goods and services does the HICP cover? Those which best represent households’ average consumption patterns. The goods and services households tend to spend more on are given a greater weight in the index.
So, the impact on the index of a change in the price of a specific good or service depends on households’ consumption patterns: the more typically spent on this good or service, the more the change in its price will influence the HICP.
For example, households spend much more on electricity than they spend on butter. Therefore, a change in the price of electricity will have a much bigger impact on the index than a change in the price of butter or that of many other items in the consumption basket.
And what happens to our savings?
As we mentioned above, when inflation occurs our money loses value.
Therefore, if we want to calculate the potential return on an amount of money we’ve decided to save or invest, we have to consider inflation and correct the expected return by deducting the inflation rate.
To prevent our savings from losing value over time when inflation occurs, the rate of return we’re offered on our savings must be higher than the inflation rate.
Why is price stability important?
By price stability we mean when inflation is low, stable over time and predictable. If price developments are predictable and the inflation rate over time is low, it will be easier for us to plan our finances and the estimation of our outgoings will be more accurate. A less uncertain setting also has a positive influence on economic growth.
Therefore, the main aim of the monetary policy of the European Central Bank (ECB) is price stability, which it defines as an inflation target of 2% over the medium term.
You can find statistics and more information on inflation on the ECB website.
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