Inflation: What It Is, Its Dangers, and How to Protect Your Money

Introduction: What Is Inflation in Simple Terms

Inflation refers to the overall increase in the price level of goods and services within an economy. In simple terms, during inflation, money loses its value over time: the same amount of currency can purchase fewer goods and services than it could previously. This leads to a decrease in the purchasing power of the population. For instance, if a product cost 1000 rubles a year ago and today it costs 1100 rubles, there has been a 10% rise in prices, and the purchasing power of money has decreased by 10%. The inflation rate is typically calculated based on the Consumer Price Index (CPI), which reflects changes in the cost of a fixed "basket" of goods and services.

Inflation occurs in any economy and is even considered normal when the price increase is modest. However, a sharp rise in prices can complicate life for businesses and ordinary citizens. For example, in post-war Germany during the 1920s, prices rose multiple times a day, and money was almost entirely devalued.

Causes of Inflation Growth

The primary causes of inflation growth are usually attributed to the following factors:

• Excess demand. When the aggregate demand from the population and businesses significantly exceeds the economy's capacity to produce goods and services, sellers raise prices. Demand increases, while supply is lacking, leading to price growth.

• Rising production costs. Increases in the prices of raw materials, energy, transportation, or labor create higher production costs. In such conditions, companies pass on the increase in expenses to consumers.

• Excess monetary supply. If the central bank sharply increases the money supply in the economy, outpacing the growth of real indicators, the excess money contributes to inflation. Excessive issuance, for example, to finance a budget deficit, can "overheat" the economy.

• Depreciation of the national currency. The devaluation of the ruble leads to an increase in the cost of imports—from raw materials to finished products. The rise in prices of imported goods automatically drives up the overall price level in the economy.

• Negative external factors. Supply shocks (global increases in oil prices, food prices, and other resources), as well as logistical issues or sanctions, can trigger accelerated inflation, even if the domestic situation is relatively stable.

• Inflation expectations. If the population and businesses are confident in further price increases, they tend to spend money faster or negotiate higher wages. This, in turn, accelerates demand and creates additional pressure on prices.

Most often, several factors act simultaneously, amplifying the overall price growth. Understanding the causes of inflation is crucial to assess the problems it creates for the economy and the population.

The Dangers of High Inflation for the Economy and Citizens

A high level of inflation poses serious challenges for the economy and citizens. First, it reduces the real purchasing power of the population: even if nominal incomes are increasing, prices are rising faster, and people can afford fewer of the same goods. This is particularly hard on retirees and those on fixed incomes, as their earnings are effectively devalued.

Second, high inflation creates economic uncertainty: businesses cannot accurately plan investments and expenses, raising the risk of project losses. The central bank must increase the key interest rate to "cool down" the market, making loans more expensive and slowing economic growth. Furthermore, during rapid devaluation of money, people tend to spend or invest their funds more quickly, which can lead to an overheating economy and new cycles of price increases. In turn, accelerating inflation affects competitiveness: prices for export goods are rising faster than in other countries, negatively impacting the trade balance. Inflation undermines trust in the national currency: citizens and businesses look to convert their savings into dollars, euros, or other reliable assets. Capital outflows weaken the ruble and create additional stress for the economy.

Finally, inflation impacts social stability. Sharp price increases often lead to a decline in living standards, growing public dissatisfaction, and protests, especially when wages do not keep pace with inflation. Thus, high inflation signifies the devaluation of money, a decrease in the quality of life for many segments of the population, and overall economic destabilization.

The next step is to understand how inflation affects personal savings and investments.

How Inflation Affects Savings and Investments

Inflation directly reduces the value of accumulated funds. Regular bank deposits and cash savings lose purchasing power if interest rates on deposits are lower than the inflation rate. In other words, with money in the bank over time, one can purchase fewer goods. For example, if inflation is 5% per year and the deposit rate is 3%, then the real income from savings is negative, and their purchasing power decreases. For the same reasons, fixed monetary investments, such as government bonds with fixed returns, also lose value: their real yield declines when inflation rises. This means that the market price of such bonds falls, and investors must agree to a higher interest rate upon purchase.

When investing, the impact of inflation is twofold. On one hand, companies can increase revenue as prices for goods and services rise, so stock quotes and real estate prices may sometimes increase along with inflation. On the other hand, excessively high inflation creates instability: businesses face rising costs and may struggle to keep pace with rapid price increases, while uncertainty decreases investment activity. Real assets (such as gold, real estate, and currency) are traditionally considered a reliable safeguard against inflation, as their value typically does not decline during money devaluation.

Ways to Protect Against Inflation

• Investing in real assets. Real estate, land, precious metals, and other tangible assets traditionally serve as a reliable hedge against inflation. Their value generally increases over time, aligning with the overall price growth.

• Inflation-indexed securities. In many countries, there are bonds whose returns are indexed to the level of inflation (e.g., OFZ-PD in Russia or Treasury Inflation-Protected Securities in the United States). These instruments help preserve real returns during price increases.

• Budgeting for inflation. Planning personal or corporate budgets with reference to the inflation rate helps maintain purchasing power: projected income and expenses are adjusted for expected price growth.

• Stocks and mutual funds. Investing in shares of promising companies or index funds allows investors to benefit from business growth. During inflation, company revenue increases alongside prices, which over time raises the value of their stocks.

• Foreign currency. Purchasing dollars, euros, or other stable currencies helps preserve savings if the national currency depreciates. Currency savings act as a "safe haven" during significant ruble devaluation.

• Diversification of investments. Combining different types of assets (deposits, bonds, stocks, currencies, commodities, etc.) reduces risks: even if one part of the portfolio loses value due to inflation, other assets can offset those losses.

Conclusion: Why It Is Important to Account for Inflation in Financial Planning

Inflation is an inherent factor in modern economics, so it should be considered during long-term financial planning. By accounting for potential price growth rates, governments, businesses, and individuals can make more informed decisions: incorporating inflation expectations into budgets, adjusting future income and expenses, or selecting investment instruments that can preserve the purchasing power of savings.

Taking inflation into account allows for adjustments to financial plans: investors and funds can estimate the income level needed to outpace price growth. For example, many social benefits and pensions are regularly indexed according to expected inflation rates to prevent a sharp decline in purchasing power among vulnerable segments of the population.

Without accounting for inflation, many calculations would be overly optimistic: savings plans might not ensure the desired living standards, and enterprise profits could fall short of expectations. Any serious budget or financial plan must include an inflation forecast to avoid such errors. Capital growth is directly linked to whether incomes exceed price growth rates. Therefore, prudent financial planning always involves monitoring inflation levels and utilizing protective measures to maintain the real value of funds.