How Inflation Affects Savings & Why Never Keep Money Idle
When we think about saving, the idea of keeping the money idle in your house is not good. It is true that, if you put money in your cupboard/anywhere in the house for years, in the end you get a very important savings fund. The problem is the final value of that money saved at home. If you save Rs. 20,000, you will have the same Rs. 20,000, but that money may not allow you to buy the same stuff as before because of the inflation i.e. it’s value of your money goes down.
In this sense, when inflation is taken into account in our savings and consumption decisions, it is better explained why it is not a good idea to leave the money under the mattress.
What is inflation?
Inflation is the increase in the price of goods and services over time. Banks typically defines inflation as the increase in the general level of prices, for example, in the consumer price index (CPI).
This index, created from the price of different products and services in the shopping basket, marks inflation at all times. The CPI of a specific month is compared with that of a year earlier to see its variation. If prices increase there is inflation, but if prices fall, deflation occurs.
When inflation rises, prices are more expensive, while savings are lower because rupee is worth less and less. This means that with the same money you can buy fewer products and services and, therefore, you lose purchasing power.
How is inflation controlled?
There are different types of inflation that affect both the general and the personal economy. Depending on what inflation is, the measures adopted for its control affect us in one way or another. For example, high inflation is controlled by rising interest rates, which has negative consequences for those who have loans or mortgages.
When the rates rise, it tries to contain inflation and stabilize prices, because there is less demand for money through loans. On the contrary, when the rates fall, mortgages become cheaper, customer demand increases, but, at the same time, the profitability of savings is lower.
How does inflation affect savings?
The goal of saving money is to obtain the highest possible return. In general, the higher the interest rate, the greater the profits for the saver. However, this performance would have to be subtracted from inflation to know what the final gain is. That is, when rates are high, inflation is also high, so we must discount this, while, if inflation is 0, we should not subtract anything from the perceived returns.
For this same reason, it is not a good idea to save money i.e. keep it lying idle, because money loses value over time, suffering the effects of inflation. Money is devalued with inflation, which means that, if we keep Rs. 20,000 unused, with 3% inflation at the end of the year, even if we have the same amount, its purchasing power will be decreased by Rs. 600.