Understanding The Concept Of Inflation

“It was much cheaper in the good old days”. My guess is you have probably heard your parents or grandparents say something like this. They were able to buy a house for half the price of a Toyota Corolla “back in the day”. However, they didn’t mention that they were making 1$/hour. So was it really cheaper back then?

The fact that the price of goods & services keeps increasing over time is due to inflation. This is one of the 5 risks of retirement. It is probably the most dangerous one as it can seem insignificant and is totally beyond our control. How can inflation of 2.5% really affect my lifestyle? What I pay $100 today, I’ll pay it $102.50 next year…. Big deal!

However, the same item at $100 will cost $209 in 30 years at an inflation rate of 2.5%. Your house that is worth $250,000 today will be worth $524,000 based on the same principle. The worst part is that you if you retire between 60 and 65, your chances of living 30 more years are pretty good! Therefore, you absolutely need to consider the impact of inflation in your calculations (this will be shown in a later post).

Where does inflation come from? 

Inflation is the result of a vicious circle: When economy goes well, people tend to buy more. Therefore, we need to produce more of everything. Since resources are limited, prices will slowly go up to adjust to the demand (economics 101). This is one of the reason why prices climb.

Then, employees ask for a raise because:

#1 There is a lot of competition to retain good employees

#2 The company is making profits (remember, we are in a good and healthy economy)

#3 They want to keep up with the inflation

So if companies have to pay their employees higher wages, there is a good chance they will increase the price of good & services and help fuel inflation again.

During an economic crisis, we often experience a low inflation rate. The economy is slowing down, people don’t buy much anymore and prices will slowly decline. The opposite of inflation is called deflation (when overall prices go down). This will be discussed in a another post as well (you don’t want to read this post forever… you still have to work to pay for your retirement ).

How is inflation calculated? 

To make it simple, imagine that you take $100 and to buy specific items with it. The year after, you take the same shopping list and you calculate how much it cost. If the total is $103, this means that the inflation rate was 3% during that year.

There is a specific list of items that reflects an idea of “the normal cost of living”. This list is generally determined by a government agency and you can follow the CPI (Consumer Price Index) from your government websites:

Canada CPI

US CPI

UK CPI