Understanding Inflation

What is Inflation?

Inflation is what happens when money loses its purchasing power, which shows up as an increase in the prices of the goods and services households typically buy.
Put another way: a dollar today is worth less than a dollar was a year ago.

What is Inflation Supposed to Be?

You’ve probably heard in the news that the Reserve Bank of Australia (RBA) aims to keep inflation sitting at 2 to 3%. Keeping inflation in that range preserves the purchasing power of money and encourages sustainable growth across the Australian economy, which ultimately benefits everyone.

In recent years, post COVID, that target spiralled well out of control, peaking at 7.8% in December 2022.

Case Example #1

Steven is given $100 for his birthday on 1 January 2025 by his loving wife Cynthia. He leaves the cash sitting in his wallet.
Inflation runs at 5% through 2025.
By 1 January 2026, that same $100 is only worth around $95 in real terms. He hasn’t spent a cent, but he’s lost about $5 in value just by doing nothing.

Case Example #2

Daniel puts $100 into a regular bank account on 1 January 2025, planning to buy a collectible.
Inflation runs at 3%.
A year later, when he goes to buy that same collectible, he now needs $103 to cover the price rise.

Case Example #3

2 litres of milk and a loaf of bread costs $10 in 2025. Assuming 3% inflation each year:

  • 2026: $10 x 1.03 = $10.30 (up $0.30 on the year before)
  • 2027: $10.30 x 1.03 = $10.61 (up $0.31)
  • 2028: $10.61 x 1.03 = $10.93 (up $0.32)
  • 2029: $10.93 x 1.03 = $11.26 (up $0.33)

In just four years, that same shopping basket has gone from $10 to $11.26. Nobody notices this happening week to week, but it adds up fast when you zoom out.

Why Understanding This Matters

Here’s the bottom line: leaving money sitting as cash, or parked in a regular bank account, is quietly losing you money. To protect against this, you need to find productive things to do with it, so its value isn’t eroded year after year.

What Can You Do Right Now?

Any cash you’re not actively investing should at minimum be sitting in a High Interest Savings Account (HISA), which at least helps you keep pace with inflation rather than losing to it outright.

If you have money you know you won’t need for at least 7 years, it’s worth considering putting it to work in something with higher long term returns, like property or shares, since these have historically outpaced inflation by a wider margin, but only if you’re prepared to keep that money invested for the long haul or done your own research.