IC Markets

Inflation? What is it, really?

In recent years, the topic of inflation has once again gained traction, and in the past few months, numerous articles have been published about it daily. Many people envision a globally higher and more persistent inflationary environment compared to the previous decade. Inflation is a crucial phenomenon for individuals in terms of their cost of living and for investors as well. In our current 5-part blog series, we will explore fundamental topics related to inflation, aiming to provide a good overview rather than creating noise or excessive depth.

We could start this post with catchy sentences, but instead, we'll begin with a dry one for the sake of order. Let's clarify from the outset that, in theory, inflation is nothing more than the rate of money's deterioration. It's essential to understand that products are typically measured in currency rather than being compared to another product or service. (For example, a phone's price is expressed in forints in Hungary, not in how many kilograms of apples one must give in exchange.)

In theory, changes in the prices of various products demonstrate how the value of money as a medium of exchange changes over time. As money loses value over time, more money must be paid for goods and services, which means people have to pay more for food, drink, or phones.

However, many factors influence this general idea. One such factor is the distinction between general inflation and product-specific inflation:

General inflation applies to a larger consumption basket and aims to reflect the inflationary impacts on average consumption. This basket consists of many products and services, where numerous unique effects are likely to cancel each other out over the long term. Individual products, on the other hand, always differ from one another at any given moment, with varying inflation levels. In some cases, supply chain disruptions cause shortages, driving up the price of these products temporarily. Regulations can also impact prices, either upwards or downwards. In the latter case, if, for example, bad weather affects agriculture and causes the prices of some products to rise, it doesn't necessarily mean a rapid decline in the value of money, even if inflation indicators start to climb. Similarly, if public transport pass prices remain unchanged for ten years, it doesn't signify the disappearance of inflation. When talking about inflation in everyday language, we tend to forget this.

Beyond these thoughts, readers might wonder why all of this is important.

Inflation typically shows a single-digit percentage value annually, but its effects accumulate over the long term. Today, one can buy many things and use many services for 1 million forints. The situation probably won't change drastically next year, as the average annual inflation rate over the past 20 years has been 3.8%. However, in 5-10 years, it's highly likely that significantly fewer products and services will be available for the same amount of money.

Although we might not have any significant influence on the inflationary environment surrounding us, it's still worthwhile to have a basic understanding of inflation's driving forces and expectations due to the long-term impacts. This doesn't even take into account the differences between general consumer baskets and individual products.

But what causes low or high inflation rates? What changes affect them the most? And, of course, the crucial question: what is a healthy inflation rate? Why can't it simply be zero percent? We will explore these topics in the next part of our blog series.