Inflation is the increase in the price of a certain object or objects over time. It is calculated by the increase in the price divided by the original price and multiplied by 100 to be expressed as a percentage. For example, if a banana cost 50¢ one year and then 52¢ the next, then its price would have inflated by 4% (2¢/50¢).
In New Zealand, inflation is measured in several ways. A key metric is the Consumer Price Index (CPI). This tracks the change in prices of almost everything that a consumer (you) spend your money on, including food, clothing, housing, medical, transport, entertainment, communication and education [1]. These price changes are all brought together to give the overall average change in prices. Currently (June 2020) the annual inflation rate is 1.5% [2]. You can find the most recent NZ CPI value at Stats NZ, as well as data going back decades.
Another way of looking at inflation is called purchasing power and the ‘real’ value of money. Imagine you had $100 and you were wondering if you should buy something worth $100 or put that money under your bed. If you were to put the money under your bed for 5 years and the inflation rate was 1.5% per year, then the thing you wished to buy would now be worth $107.70 and you would not be able to buy it with your $100. This means that the purchasing power of the money has gone down- it can no longer buy what it could before. Alternatively, it can be said that your $100 in 5 years’ time is only worth $92.83 in today’s money.
This is why inflation is considered to be a thief- it effectively steals your money if you don’t use it. This shows how important any kind of investing is. If you put your money in a bank account, then you reduce the amount you lose to inflation and may even beat it if you get a good term deposit rate.
An important point to note is that inflation is often reported on a quarterly or yearly basis. This means that the increase is only relative to the start of the period that it measured. For example, if inflation were reported to be 2% at the end of every year, you might think that the price increases each year would be the same. However, each successive year, the price that is used to divide the increase get bigger and so does the price increase. This is shown in the first table below. You can see that by the end of the 20th year, the yearly inflation is still 2%, but the actual price increase is 2.91¢ or 2.91% of the original $1.00. Additionally, look at the overall inflation- by the end of 20 years, the item will have increased in price by almost 50%.
An alternative way of looking at this is if the price increase were the same each year. Now, the price has increased by only 40% by the end of 20 years and the yearly inflation has dropped to 1.45%.
This shows the importance of understanding what inflation is, what it means and what numbers you are looking at. Of course, these numbers are somewhat arbitrary, prices don’t increase by a constant $ amount or a constant % per year and inflation will go up and down.
References
[1] Stats NZ, "Consumers price index: March 2019 quarter," Stats NZ, Wellington, 2019.
[2] Stats NZ, "Consumers price index (CPI)," 16 July 2020. [Online]. Available: https://www.stats.govt.nz/.
