Don't understand inflation - please help!

jamtart6

Ok inflation as far as I see is when the cost of living goes up? I don't understand what it means in terms of savings though.

Does it mean that if you put £5000 in the bank in 1990, that £5000+interest would buy less today than it would in 1990?

If so, are savings accounts not good?

Sorry to sound thick, I have no idea what it means! :D Can anyone help explain it please? :A

Aegis

jamtart6 wrote: »

Ok inflation as far as I see is when the cost of living goes up? I don't understand what it means in terms of savings though.

Does it mean that if you put £5000 in the bank in 1990, that £5000+interest would buy less today than it would in 1990?

It depends. If the interest rate is higher than the inflation rate, then your real value will increase. If the interest rate is lower than the inflation rate, then your real value will reduce. Of course, this all becomes a little tricky to analyse if you don't use your personal inflation rate, which you'd have to calculate yourself. However, if you go with CPI or RPI (depending on whether you rent/have a mortgage or outright own your property) you'll probably be more or less fine.

If so, are savings accounts not good?

In the long run they fail to beat inflation by enough to matter to a lot of people, which is why most recommend asset-backed or fixed-interest investments in the long run. They tend to outperform cash in the long run, which is why even pensions tend to go at the very least into a balanced fund in the long term, even for cautious retirement planners!

Hope that helps a little.

Mikeyorks

Aegis wrote: »

Hope that helps a little.

As ever, it helps a lot.

But worth mentioning that it is the net interest figure you measure against inflation .... if you pay tax on it?

Aegis

Mikeyorks wrote: »

As ever, it helps a lot.

But worth mentioning that it is the net interest figure you measure against inflation .... if you pay tax on it?

Absolutely, and well pointed out!

Yes, you need to compare your net interest rate rather than your gross rate. Obviously if you have to deduct 20 or 40% from your interest rate, this is going to have huge implications for whether your savings can beat inflation in the long run.

liitleblackcat

As discussed in another thread this week, inflation is different for different people and for different commodities and RPI is a poor indicator of inflation for any individual item.

For example, £5000 in 1990 would have bought you a pretty good computer for the time (256k RAM, Intel 386 processor, 20MB hard drive. Today, £5000 + interest would buy you something ever so slightly better! Similarly for most electrical goods and clothing.

However, many things increase in cost over time at a higher rate and interest on savings after tax will not generally keep up with it, so the value of savings goes down in real terms over time.

nrsql

Well the Daily Mail site has an article on inflation.
I would assume that the figure are sensationalised but the gist is probably reasonable.

http://www.dailymail.co.uk/pages/dmstandard/frame.html?in_bottom=http://www.thisismoney.co.uk/news/article.html?in_article_id=440527&in_page_id=2&ct=5

Here's the CPI guide and changes - doesn't seem to match the above very well
http://www.statistics.gov.uk/pdfdir/cpi0408.pdf

The figures are here and give a link to the guides
http://www.statistics.gov.uk/instantfigures.asp

Anyway the inflation rate values are not applicable to any person - you would need to view what you spend money on. How often do you buy TV's, furniture, white goods, how much do you spend on food, travel etc.

Mikeyorks

nrsql wrote: »

Here's the CPI guide and changes -

Pleased you posted that - as had intended to look at the RPI figure for March (and forgotten) .... following some exchanges on Student Loans last month.

As the March RPI figure sets the interest rate on Student Loans from Sept 08 - Aug 09. So ..... they at least will be pleased it will be down to 3.8% from the 4.8% currently being charged.

meester

the other thing to mention is that if you invested £100 in 1900 and it kept up with inflation (giving you about £75,000 in today's money) you would not be as wealthy relatively now as you would have been then.

Inflation should be less than the increase in people's wealth, due to efficiency improvements. It is not enough to merely keep up with inflation, otherwise you would still be living a 1950s lifestyle with no washing machine, microwave, or flat screen TV. Wages are a better target for your investment benchmark.

surreysaver

This is quite interesting:

www.parliament.uk/commons/lib/research/rp99/rp99-020.pdf

gives historical inflation rates back ro 1750

nrsql

Here's the figures up to 2007
http://www.safalra.com/other/cumulative-historical-uk-inflation/

xiox

Have a look at this article if you want to know what inflation is: http://mises.org/story/2914

Basically, most inflation comes from the increase in money supply which dilutes the value in each pound you earn. Basically, the huge amounts of credit pumped into the economy by banks have increase hugely the number of pounds in circulation. This has given us large inflation. As most of this money has gone into buying overpriced property, this has given us the ridiculous house price bubble recently. This was not measured by CPI, the government's measure of inflation, so they tell us inflation is really low. It's interesting to see what will happen now there is little credit being pumped into the economy by the credit crunch. Will wages have to be put up to keep inflation high?