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Value retention
Inflation made simple
Investors worry about preserving the value of their savings. The word inflation often makes people fearful. However, inflation should not be a source of stress, as once you understand it, you also know how to protect yourself from it.
Content:
Content:
- When inflation occurs, the value of money, and therefore purchasing power, decreases.
- The causes of inflation are increased demand and higher production costs.
- Persistent price increases usually result in slower economic growth.
- A low inflation rate of up to 2 percent is to be regarded as positive and is also the target rate of the Swiss National Bank.
- To the conclusion
Investors are afraid that their savings will lose value. How justified is the fear of devaluation? We explain what terms such as inflation, deflation and real interest rates mean.
It’s normal for the market prices of products or product groups to go up and down. If only a loaf of bread or your upcoming vacation becomes more expensive, this is not inflation. Rather, inflation is a general and persistent increase in prices. This means that the prices of many goods and services will rise over a longer period of time.
This price increase reduces the purchasing power of consumers, who cannot afford as much as they could before.
Inflation can have several causes, but there are two main factors: stronger demand and increases in the costs of production.
It may arise on the side of demand or the supply of goods. For example, prices can rise if consumers demand more products and services than are available. If companies are not able to increase their production promptly, they raise prices.
Prices can also rise because production costs increase on the part of the manufacturers – the supply side. This can happen if raw materials become more expensive or wages rise sharply. Changes in the exchange rate of the Swiss franc against other currencies can also have an impact on local prices, for example if imports become more expensive as a result. The widespread passing on of these costs leads to rising prices.
How is the inflation rate calculated?
How is the inflation rate calculated?
In 2023, inflation in Switzerland was on average 2.1 percent. In 2024, an inflation rate of 1.1 percent is expected, and 0.7 percent is expected in 2025. But where do these figures come from?
Inflation is calculated on the basis of a representative basket of goods, which is made up of a bundle of selected goods and services. A price index is calculated for the entire basket of goods, the change in which is the “inflation rate.” This compares today’s price of this basket of goods with that in the same month last year.
In Switzerland, the Federal Statistical Office (FSO) measures inflation using the National Consumer Price Index (CPI). The selection and weighting of the products in the CPI shopping basket is not arbitrary, but is intended to reflect the typical needs of a household. The shopping basket contains, for example, the categories “housing and energy,” “transport,” “food and nonalcoholic beverages” or “leisure and culture.”
Over time, the composition of the basket changes. In order to record current consumer habits, the Federal Statistical Office carries out random checks on an ongoing basis. Each time, around 250 households record in detail how much money they spend on what each month.
Example for the calculation of the inflation rate
Example | Example | Year 1 | Year 1 | Year 2 | Year 2 | Year 3 | Year 3 | Year 4 | Year 4 |
|---|---|---|---|---|---|---|---|---|---|
Example | Price of the representative shopping basket | Year 1 | CHF 1,000 | Year 2 | CHF 1,025 | Year 3 | CHF 1,100 | Year 4 | CHF 1,100 |
Example | Price index | Year 1 | 100 | Year 2 | 102.5 | Year 3 | 110 | Year 4 | 110 |
Example | Inflation rate (change relative to the previous year in percent) | Year 1 | 0 | Year 2 | 2.5 | Year 3 | 7.3 | Year 4 | 0 |
The consequences of persistently sharp price increases are undesirable from the consumer’s point of view. While stable prices provide reliable signals for consumption and production, inflation increases uncertainty about further developments.
The impact of inflation
The impact of inflation
Purchasing power
If the general price level rises, households can buy less for the same amount of money. Purchasing power falls. This happens insidiously. Over a period of 10 years, 100 francs lose almost a fifth of their value, even with only a low annual inflation rate of 2 percent.
Economic growth
The reduced purchasing power of money lowers the demand for products. Companies respond to this, for example by investing less, which in turn slows down economic growth. In addition, they cover their costs in the long term through price increases.
Investments
Inflation affects the returns on interest-bearing investments such as savings accounts and fixed-income securities. It reduces the interest earnings that remain after deducting the inflation rate from the nominal interest rate. If the inflation rate is higher than the nominal interest rate, the real interest rate becomes negative. Savings lose value.
Through its key interest rate decisions, the Swiss National Bank has an important role to play in curbing inflation and ensuring a stable price level. In general, inflation is not fundamentally negative, and low inflation is actually desired by politicians and the business community. For example, the current inflation target of the Swiss National Bank is a maximum of 2 percent. Low inflation is desirable because it goes hand in hand with growth. As companies anticipate higher prices, they invest more. They can pay higher wages and their employees can buy more. Low inflation also protects against deflation.
What is deflation?
Deflation is a danger to the economy. It’s the opposite of inflation: instead of increasing, the general price level decreases. Deflation can be caused by lower demand in the event of a surplus of goods. The result could be a crisis which companies find it difficult to find their way out of. If consumers expect prices to keep falling, they postpone their purchasing decisions – and for the time being only buy the essentials. Deflation is considered just as threatening as persistent inflation by the Swiss National Bank.
Sample calculation: After one year, a balance of CHF 10,000 earning a fixed interest rate of 2.0 percent would be worth the following in real terms:
- at 1.5 percent inflation: CHF 10,050
- at 4.0 percent inflation: CHF 9,800
- at –4.0 percent deflation: CHF 10,600
Inflation is the ongoing loss of value due to wide-ranging price increases. However, low inflation should be viewed as positive, as companies can expect higher prices and thus invest more. In this way, they also increase employees’ willingness to buy, as they pay higher wages. All of this boosts economic growth, while high inflation slows economic growth. This is because the higher inflation is, the lower consumers’ purchasing power will be.
Through its key interest rate decisions, the Swiss National Bank has an important role to play in combating and curbing excessively high inflation. The Swiss Federal Statistical Office (FSO) is responsible for calculating the inflation level in Switzerland. The calculation is based on the National Consumer Price Index (CPI).
Disclaimer
Disclaimer
