To ask for an explanation of inflation, as if I’m a 5 year old?

[ChangePlease]

I thought I understood it, but reading some things recently in the FT I don’t think I do. Which is embarrassing.

There are loads of online explanations. Just google "easy economics inflation" to find an explanation at the right level, e.g.

What was your understanding and what did you read that confused you?

There’s no point in someone explaining the basics if that’s what you already knew, but some obscure financial theory/model says otherwise.

Last year your salary was 10$
With those 10$you could buy 10 pieces of candy

This year your salary is 10$
But with that 10$ you can now only buy 9 pieces of candy

I just explained it to my 8 yo that the same amount of money buys less. I used a real life example that my tub or butter used to cost me £3 but now it costs £4 because of inflation. The price has been inflated (has grown).

So although I still have the same amount of money i can get less with it. So in my example previously £9 would buy me 3 tubs of butter, now it will buy me only 2 with £1 to spare. My money is worth less than before.

The painful bit that people often don't understand is that pay rises "lock in" inflation by making the higher prices more affordable. The current inflation is being caused by a combo of pressures (mainly Covid & Putin) which could ease in a year or too, but if wages have risen in the meantime, so that demand for goods remains high, then prices will stay high rather than coming down when the pressures ease.

The price of goods goes up.

The reasons can be complex, but the impact we see is simple.

What Truss is doing on energy is locking in the energy price rises btw, because instead of asking energy companies to reduce the costs (by using their profits) we are agreeing to pay more (by using government borrowing).

The government are opposed to ordinary people being any better off due to pay rises, but are happy for energy comapnies to be better off due to taxpayer bungs.

Some level of inflation (say around 2% per year - so the price of a week’s groceries increases from £100 to £102) is a good thing. Zero inflation would imply a sluggish stagnant economy, and wages rise too to meet the costs.

But when inflation is too high, wages don’t keep up and the outcome is poverty.

High oil prices causes higher prices for everything. Because everything needs to move from A (where it is produced) to B (where it is sold) and that costs more when fuel prices are high.

One thing to also remember that I think people sometimes forget is that the official inflation rate is a measure of price increases that have already happened. It's not a forecast of prices rises that will happen in the future.

The Office for National Statistics has a list of goods and services weighted by the amount that the typical household will spend on those items and the price rises of those items is used to calculate the official rate.

Which is why inflation might be 10%, but you look at how much your food, utilities or petrol has gone up and you find that it's a lot more than that. Because other things go into the average calculation.

Of course that leads to problems when your spending is not like the average, which mainly effects lower income households, who spend a far larger proportion of their income on basic essentials so if prices of these items rise more than the weighted basket, their personal rate of inflation will be higher, which compounds the problems they have in making ends meet.

Also, it's worth understanding that the price of candy has not gone up because the amount of candy has decreased, making the candy that is available scarcer and more expensive. Instead, while candy availability has remained constant, the amount of money has increased, making money more available and therefore worth less. This is why government handing out more money to everyone can't actually make us better off. In order to be better off, we need to actually produce more, by working cleverer or harder.

@Getoff so how has the amount of money available increased? And what does ‘more money available’ mean in a practical sense to the average person?

thanks for all these explanations by the way, although raised ever more questions!

It hasn't. An over-supply of money is not what is causing the current inflation - it's being caused by under-supply of energy and other commodities, such as wheat. But if wages are increased in response to the rise in prices, or if governments "print more money", the prices won't come down when the supply issues are resolved.

Women's hour had a segment the other day on explaining economics. Can't remember if it included inflation but here's the link in case of interest

podcasts.apple.com/gb/podcast/womans-hour/id130950322?i=1000576921944