What is inflation and what are its effects?

Estimated reading time
 8 min

In this article

• The definition of inflation
• What does inflation mean for me?
• How can I prepare for inflation

Inflation, inflation, inflation. If you live in Australia, you’ve probably heard the ‘I’ word a lot this year… and you’ve most likely felt it, with prices going up at your local supermarket, or a rise in your utility bills.

But while many people get what inflation means at surface level, dealing with it can be easier if you know exactly how it works and the flow-on effect it can have on your finances.

After all, it’s how you’ll measure how much of a pay rise you might need to keep the same lifestyle, it helps estimate how much money to put aside for the future, and is even important for your daily budgeting.

So are you ready? Let’s go.

What is inflation, exactly?

According to ANZ senior economist Adelaide Timbrell, inflation is “a change in the prices of commonly purchased goods and services over time.” Or in other words, it’s the increase in your living expenses over a certain period (typically a year)¹.This includes everything from groceries and clothing, to housing and transport.

In Australia, the rate of inflation is based on something called the CPI – or the Consumer Price Index, which is essentially an index of the prices of everyday items across the country. This is compiled quarterly by the Australian Bureau of Statistics (ABS), and any change in prices over time contribute to the end product, the inflation rate. Some prices go down over time and others go up quickly, but on average prices generally go up. The more common an item is, or the more important it is for a household budget, the more a change in its price affects the inflation rate. For example, if inflation is 5%, it means that on average, all the prices in the CPI went up by 5%, but it could mean some prices went up by 10% and others went down by 2%.

Ok… but why does it matter?

Ms Timbrell noted that "inflation is important to our day-to-day lives because if our incomes stay the same, but prices go up, we can buy less over time. This is especially noticeable when inflation is moving at a faster rate, or when inflation is driven by rising prices of essential goods and services, like electricity, groceries or housing costs."

What’s the current inflation situation?

In the year to September 2022, inflation in Australia rose by 7.3 per cent².  The ABS notes that the most significant price rises were “New dwelling purchases by owner-occupiers (+3.7% q/q), Gas and other household fuels (+10.9% q/q) and Furniture (+6.6% q/q)”.

This is the fastest rate inflation in about 30 years, and is due to a range of persistent local and international factors.

One key factor both at home and globally is the lingering effect of government spending and low interest rates after the COVID-19 pandemic, which put more money in people’s pockets and created a “bottleneck” of spending. Ms Timbrell explained, “when more people want to buy the same thing at the same time, companies don’t have to compete as much on price to sell their items”.

Other global factors like the Russia Ukraine conflict have made key commodities more expensive, which feeds into prices of common goods and services. For example, if petrol is more expensive, then it costs more to get food from the farm to the supermarket.

So, how do I protect my financial wellbeing in the face of inflation?

ANZ research published last year showed that one of the biggest concerns for Australians during the COVID-19 pandemic was confidence in their current and future financial situation. The good news is there’s lots of things you can do – big and small – to help improve your financial wellbeing, and build resilience in the face of all kinds of change, inflation included. At the end of the day, it’s about ensuring you, and your loved ones, feel secure for today – and the future. 

Some things you can do now include:

• Planning your budget
• Reducing everyday expenses
• Spending carefully
• Saving for a rainy day

Three quick facts about inflation

ANZ senior economist Adelaide Timbrell’s top 3 myths and facts about inflation:

1. Yes, exchange rates do affect inflation

When the Australian dollar is weaker on a global scale like it is at the moment, this can push inflation up. This is because we have to pay more in Australian dollars to buy goods and materials from overseas, even if they are the same price in the seller’s country’s currency. So the price Australian products need to be sold for here goes up, to recover costs.

2. Immigration doesn’t necessarily affect inflation

A common misconception is that immigration helps inflation go down because more people living in Australia means more people to work jobs, and less competition for workers. But in reality, people who migrate to Australia have houses, cars and go out for dinner just like any other resident – which increases the demand for workers. Overall, the impacts mostly offset each other.

3. Wage growth doesn’t equal inflation

When Australia’s average wages go up, people sometimes think this will just be offset by inflation. For example, if it’s more expensive to pay people in a business, wouldn’t that just make the products more expensive for the customers? But sometimes what we’re seeing is actually just more people switching to better jobs. If you’re getting paid more but doing more valuable work, that bigger paycheck is not going to be passed on. And even if you’re doing the same job for more money, it still would not be completely offset by a rise in prices, since the cost of workers is just one of many costs for a business.

How can I prepare for inflation changes?

Ms Timbrell said inflation isn’t just about making life more expensive. “It also creates uncertainty, because people can’t plan ahead as much if they don’t know how expensive it will be to pay for the essentials in the future”. Eventually, inflation might “come back down to earth” and settle at the target rate of 2-3% - economists and the Reserve Bank of Australia (RBA) say this could happen by 2024. This does not mean life will be “cheaper”, but rather that everyday goods will be getting more expensive, but much more slowly. Until then, you can build resilience to prepare for any changes and educate yourself on all things money management.

ANZ’s Financial Wellbeing program can provide you with insights and resources to feel better about your money. There’s even a free, 6-week course where you receive weekly challenges, coaching, tips and tools direct to your inbox. You can find out more here.