Also known as: Rising prices, Inflation
Inflation
The general rise in prices across an economy, which gradually erodes the purchasing power of money: the same sum buys less in a few years than it does today.
Prices in the shops rise over time. The same banknote therefore buys less in a few years than it does today. Nobody took your money: it simply lost part of its power.
Inflation does not show up overnight. It is a slow, almost invisible process you notice only when looking back over ten years.
How it is measured
The statistical office tracks the price of what is called the consumer basket: a set of ordinary goods and services households buy: food, energy, housing, transport. The change in its total price against last year is the rate of inflation.
That is why your personal inflation can differ from the official one. If you rent in Bratislava and drive a lot, rising rents and fuel affect you more than the average household.
How inflation eats into value
Converting a future sum into today's purchasing power is simple:
where is average annual inflation as a decimal and the number of years. It is the same mechanism as compound interest, only working against you.
A worked example
You put €10,000 in a safe and leave it there for 20 years. Average inflation runs at 3% a year.
At the end you still have exactly €10,000. Its purchasing power, though, corresponds to about €5,537 in today's money: inflation quietly took almost half the value.
Why it matters for saving
If a savings account pays 2% and inflation is 3%, you are getting richer in nominal terms and poorer in real terms by roughly one percent a year. The gap between the nominal and the real return is therefore decisive in any long-term decision.
- Real return
The return after inflation. You can approximate it by subtracting inflation from the nominal return; exactly, by using the Fisher equation.
Where you will use it
Inflation has to be built into every long-term plan: retirement, saving for children, and valuing future payments through discounting. On a mortgage it works in your favour: a fixed instalment is a lighter burden in real terms twenty years from now.
In the compound interest calculator you can switch on the inflation adjustment and compare the nominal value with the real one.