What is Inflation?
Inflation is a term you hear often, but how does it actually work? This guide explains what inflation is, why it occurs, and how it directly affects you as a consumer and investor.
Investments involve risk.
Understanding Inflation
Inflation occurs when the general price of goods and services increases over time. Because things cost more, you get less for the same amount of money. In other words, your money loses its purchasing power.
For a price increase to be classified as inflation, it cannot just be the price of a single product going up; the general price level across the country must rise and persist over an extended period.
Why Does Inflation Occur?
Inflation can be triggered by several different economic factors:
- Increased Money Supply: If a central bank prints too much money, the value of the currency decreases.
- High Demand: When demand for goods and services outpaces a company’s ability to produce them, prices go up.
- Rising Production Costs: If raw materials or labor become more expensive, companies raise prices to maintain their profit margins.
- Inflation Expectations: If people expect prices to rise, they demand higher wages. Companies then raise prices to cover the higher wage costs, creating a self-fulfilling cycle.
How Inflation Affects Your Savings
If you keep your money in a standard bank account with zero interest, it will lose value over time due to inflation.
Calculation Example
Assume the inflation rate is 2% per year. If a bag of groceries costs 100 SEK today, it will cost 102 SEK in one year.
If inflation remains at 2% every year for ten years, that same bag of groceries will cost approximately 122 SEK. If you kept your original 100 SEK in a zero-interest account, it can now only buy 82% of those groceries. Over 10 years, your purchasing power has decreased by 18%.
How to Protect Your Money
To protect your purchasing power, your money needs to grow at a rate faster than inflation.
We recommend that money you do not need for at least three years should be invested in funds or stocks. Historically, the stock market has provided average returns that outpace inflation. For money you need in the short term, use an interest-bearing savings account to offset some of the inflationary loss.
The Riksbank’s Target
The Swedish central bank (Riksbanken) aims to keep inflation stable at around 2% per year. A low and stable inflation rate is considered healthy, as it creates predictable conditions for economic growth.
