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I don't mind going back to daylight saving time. With inflation, the hour will be the only thing I've saved all year.Victor BorgeWritten by:
City editor, Daily Mail
Additional material by:
journalistFew people understand inflation like those who have felt its effects across a lifetime.Take Peter and Florence Brown. Peter, 58, took early retirement from teaching on ill-health grounds in 2005. He lives in Herefordshire with his wife Florence, 57, an ex-civil service scientist who now works in medical supplies. She is one of the first women who cannot retire at 60. They have two grown-up sons, Harry, 27, and Theo, 23.When they set out as a married couple in 1977, the cost of living was in stark contrast to what it is for their children today. They were paying just 18p a litre for petrol and the same for a pint of milk; a loaf of bread was 15p and a pint of beer just 38p.
“When I started out, I was on £160 a month. At the time, I was working in aboarding school and was lucky enough to have a room provided. So with my first month's pay I splashed out on a stereo which cost me the full £160. It was a big extravagance at the time,” says Peter.
“And when I started out, I worked in a clerical role for the government, earning £40 a week, so we were on about the same salary to start with,” explains Florence.
When the couple married in 1977, they also moved into their first home in Gloucester, which cost them just under £9,000. “Back then, the mortgage you could get was three times the man's salary and one-and-a-half the woman's,” adds Florence.
They have always put their finances into bricks and mortar, despite at one point paying £60 a month for it out of a £175 salary – more than a third of Peter's income.Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.Sam Ewing“When we came to sell up three years later, it was worth £18,600 but mortgage rates had also risen from 9 to 15%,” says Peter. So while the value of their asset had more than doubled, repayments were much more expensive.“Five years later we came back to Gloucester when I was made a boarding housemaster. To protect our investments, we bought a new house as our ‘retirement home' (the HM Revenue & Customs definition).
The mortgage rate had fallen to 9% and at the same time rates were replaced by council tax. So after some good advice from my professional association I started to top-up my workplace pension with AdditionalVoluntary Contributions, which helped boost my pension when I had to retire. It was the best advice I ever had. We felt rich,” says Peter.
“When we started out with our first jobs, homes and cars, we lived in very different times. At that point, we bought a nice car and the repayments cost more than our mortgage! Of course, we were lucky because we'd saved up when we lived in school accommodation,” adds Peter. "“Our eldest, Harry, works in finance and lives in London. When he entered the world of work back in 2005, his starting salary was close to my final salary as a teacher [£40,000],” says Peter.
But today, their sons' generation is looking at paying around £163,000 for the average UK home – or more than £365,000 in London. Which begs the question:When we started out with our first jobs, homes and cars, we lived in very different times. At that point, we bought a nice car and the repayments cost more than our mortgage!INFLATION BASKET FOR THE BROWNS.How much will the Browns get in 2012, at 1977 prices?.Consumer Price Indices Time Series Dataset, Office for National Statistics, November 2012.SO HOW DOES IT WORK?Let's take a closer look at how it all works. As the late American President Ronald Reagan so graphically observed during the great inflationary period of the late 1970s, inflation can be “as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.”
Runaway prices undermine economic stability and the fabric of society. In the 1920s, inflation weakened democracy in Germany's Weimar Republic when the public went shopping with wheelbarrows of marks.In modern times, surging food prices from Tunisia to Egypt have been a key factor in the ‘Arab Spring' that is still playing itself out across the region today.
Here in Britain, inflation is much less dramatic. But there is no escaping the fact that over the last few years since the ‘Great Panic' of 2007-2009, with the wages of ordinary households kept flat, price increases have damaged spending power. Citizens, especially those on fixed incomes such as the elderly, have been hurt by rising prices affecting home heating bills and the cost of transport.Higher energy prices act like tax on every household and business, pushing up the prices of manufactured goods and food produce. As seriously, for many people, inflation erodes the value of money being saved for a rainy day.
If price rises exceed the interest rate returns offered by banks and building societies, then the buying power of the money saved is eroded.
In the period following the recent financial crisis, inflation in the UK has been caused by three separate factors.
Firstly, the pound's sharp increase from 20% to 25% against a selection of currencies on the foreign exchange market: The lower the value of the pound, the higher the price of all imported goods, which pushed up the cost of living.inflation can be as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.Secondly, the rise of prosperity in Asia – China in particular – has led to an unprecedented rise in commodity prices from wheat and cocoa to copper and oil.
Finally, in June 2010, the VAT rate was lifted from 17.5 per cent to 20 per cent. As an indirect tax on most goods, this raised price levels across the board and heavily penalised people who bought consumer goods. Luckily, the inflation of the last five years has not triggered big wage demands, as was the case in the last decades of the 20th Century. When higher shop prices push up wages, the result is a wage-price spiral which pushes costs up further.
One of the reasons that inflation is more stable than it was in past decades is because the government operates an inflation target currently set at 2 per cent as measured by the consumer prices index.INFLATION TODAYConsumer Price Index, Office for National StatisticsBRITAIN USES THREE DIFFERENT MEASURES OF INFLATIONThe Retail Prices Index (RPI) is the measure most followed in Britain and is used by the government to set welfare and pensions payments. RPI includes a measure of housing costs, including mortgage interest rates.The Consumer Prices Index (CPI) is the measure of inflation used across the European Union. It tends to be lower than RPI because it excludes the impact of housing. The formula used is more sensitive than RPI as it is capable of picking up price changes caused by fashion and seasons.Movements in average earnings are measured by the Office of National Statistics (ONS) each month. It monitors what is happening to pay packets in private enterprise and for government workers.
The ONS adjusts the content of the ‘basket of goods' used to measure inflation on a regular basis. In recent times, the alterations have reflected changing technology. Traditional film processing was recently removed and the iPad added. And the food basket has been enlarged to include Guinness, pineapples and hot oat cereals and little used foods (such as instant mashed potato) have been removed.Understanding how inflation works is one thing, but is there anything you can do to protect yourself against its worst effects?
Yes – you can find the best interest rates for your savings; shop smart by buying quality, fresh, in-season produce; check that you have the best tariffs for your gas and electricity; and buy quality household goods that will last.Inflation is with us to stay; but we can take comfort in the fact that it is a declared priority of the Government to keep it under control. We are unlikely to need a wheelbarrow to carry our pounds to the shops anytime soon.
The views expressed here are solely those of the author,
and do not necessarily reflect the views of M&S Bank.