What Is Inflation And How Does It Affect You?

Inflation is something that affects every single country around the world. It is not necessarily a bad thing, but it is something you need to know about. It can be extremely confusing and hard to understand inflation. In fact while doing research on inflation I found that even the professionals had different opinions on the subject. So I will try and keep this as simple as possible for this newsletter.

Government departments track the price of things month to month. This includes everything from petrol, food, cleaning products, takeaway and much more. From this they can work out an average of what things cost say from 2008 to 2009.

The government tries to keep inflation at somewhere between 2.5% and 3.5% each year. This is monitored by the Reserve Bank of Australia. So the bottom line is that if you spent $1000 (on various things) in 2008 and in 2009 inflation went up 3%, the same products would cost you $1030.

Now you have to understand that some products will drop in prices. However what the government looks at is an average of the whole.
To show you what I mean, I have gone out and purchased 34 very standard products from my local shopping centre. These products most Australians would know and love.

Coca Cola 24 365ml can pack $23.99

Choice Beef Mince (4 star) 0.574kg $6.31 total price
This works out to be $11.00 a kilo

Beef Steak Fillet 0.298kg $8.94 total price
This works out to be $30.00 a kilo

Nestle Milo 750 grams $7.00

Ski Wild Strawberry Two Pack 200 grams $2.69

Arnott's Jatz Crackers 250 grams $2.66

Maggi Extra Delicious Chicken Two Min Noodles 82 grams $1.01

Holbrooks Worcestershire Sauce 150ml $2.29

Heinz Ketchup Upside-down 500ml $2.76

Cadbury Block Chocolate 200grams $3.00

Smiths Twisties 90grams $1.56

Farmers Union Iced Coffee 600ml $2.95

Mars Chocolate Bar 53 Grams $1.00

Bananas 1.277kg $5.08 total price
This works out to be $3.98 a kilo

McCain Pizza Ham and Pineapple 500 grams $5.00

Dairy Farmers Milk 2 Litres $3.46

The Advertiser Newspaper $1.10
(This is SA's Largest Newspaper)

Mount Franklin Chilled Water 1.5 Litre $2.67

Strawberries 250 grams $2.98

Meadow Lea Margarine 500 grams $3.29

Bega Tasty Cheese 750 grams $9.99

Uncle Tody's LeSnak 4 Pack 132 grams $4.59

Colgate Toothpaste 175 Grams $3.29

M and Ms Regular 250 grams $3.79

SPC Baked Beans Regular 425 grams $1.54

Kraft Vegemite 220 grams $3.87

Tip Top Sunblest Bread 650 grams $3.79

Spray and Wipe 750ml $4.89

Cadbury Frozen Vanilla Ice Cream 2 Litre $6.29

Heinz Spag and Tomato Sauce 820 grams $2.49

Rexona Deodorant 150 grams $6.49

White Wings Plain Flour 2kg $4.00

CSR Sugar 2kg $2.82

Carton 24 VB Stubbies 375ml $44.00

The total of these products equals $191.58.

As you can see all these products are fairly stable products that are all likely to still be available 30 years from now.

Once a year I plan to buy the same products on the same day from the same shopping centre. Then I can track my own inflation. This is to see if the government and my inflation on the 34 products run at an similar rate.

These were purchased on 21 Aug 2009. If inflation was running at 3% between now and 21 Aug 2010 this shopping bag would cost $197.32

For example:
At 0% it will cost= $191.58
At 1% it will cost= $193.49
At 2% it will cost= $195.41
At 3% it will cost= $197.32
At 4% it will cost= $199.24
At 5% it will cost= $201.15
At 6% it will cost= $203.07

Why is this important? Let’s pretend you have been working for the same employer for 10 years. Each year they reward your hard work with a 3% raise. If inflation is running at 3% your money has the same buying power as it did last year and the same buying power as it did ten years ago. This means that it cancels out any benefit from your raise.

That means that you could have effectively been working at the same place for the same money for ten years. Now when I talk about money, of course you are earning more, but it has the same purchasing power.

You would need to get a 4% raise in order to start getting ahead. Every time you get a raise you should not think about it in terms of dollars but in terms of what percentage that is. Also consider what inflation is running at for that year.

Putting it in a different way, let’s pretend you are at school and your teacher gives you a test. You study for the test and get an A+. However the teacher is tightening his standards on the next test the following week. If you put in the same effort you will only get an A-. So you have to work harder to get the A+.

This is similar to inflation. If you don’t get a pay rise for two years and inflation keeps going up (as 90% of the time it does) your money will have less purchasing power.

Let’s look at real figures. From Jan 1st 1998 to Jan 1st 2009 inflation has been running as follows.

2000 2.5%
2001 3.1%
2002 3.0%
2003 2.4%
2004 2.6%
2005 2.8%
2006 3.3%
2007 3.0%
2008 3.7%

Let’s take the example of Fred. Fred is a bus driver who took up his job on Jan 1st 2000. This was at a starting salary of $35,000. Fred is a model worker who has been an excellent driver.

Each year his company rewards Fred with a 3% pay rise. In fact by 2008 he is earning $44,336. This is a 27% increase from his 2000 wage.

However inflation has gone up by 29% (Please note this is a real figure). What this means is that if you purchased a bag of shopping in 2000 for $100 it would now cost you $129.00. As you can see, Fred is actually behind the 8 ball. He is earning less now than when he started. No not less money, but less purchasing power. Fred’s company values Fred less now than when he started, as far as what Fred could purchase with his money!

Even though Fred has been a model worker, his company has gotten away with only giving him pay rises that are LESS than inflation.
The moral of the story is that when your work gives you a pay rise how does this sit with inflation. Are they giving you any more PURCHASING POWER? Or are they only giving you the same purchasing power going forward? Or are they giving you even less!

This is an extremely interesting subject. My advice is that you should work out what amount of money you have been getting paid since 2000. If you are not getting paid 29% more in 2008 than 2000 you are actually going backwards.