Inflation: Will you be a winner or a loser?
Inflation has been a top of the agenda discussion item for a while now, but it is mostly treated from a macroeconomic perspective. But inflation basically hurts people’s purchasing power and there can be huge differences with regards to its impact on individuals. Who would be the winners and losers in case of an inflation kickoff? What is the impact of inflation on different people? Let’s consider the impact of an increase of the inflation rate in some typical life situations in Luxembourg.
If a student has taken up a student personal loan or a state loan (CEDIES) to pay for school and inflation increases, the rate of his credit is either fixed or its variation will be assumed by the state. Therefore, even if the nominative debt (the total amount) remains the same, its real value would diminish.
Young family having recently bought a house
Theory says that in periods of rising inflation, borrowers can “profit” by taking loans at fixed rates. However, it depends. A fix rate is usually more expensive than a variable rate. Because of how mortgages are built, more interests are paid at the beginning of the loan, and less in the end. A variable rate will be cheaper, at least in the beginning of a credit, allowing in the short term for saving money. Therefore, winning or losing will depend on whether the savings of a variable rate at the beginning and until inflation impacts the rate of the mortgage compensate or not the total interest cost paid via fix mortgage rate.
Further, the context of Luxembourg with some people benefitting from an annual salary increase to compensate inflation, may compensate the increase of variable interest rate.
Settled family looking to diversify financial wealth
In a controlled environment, equity markets can profit from rising inflation. If companies can increase prices and consumers’ purchasing power is not affected, then this can be positive for company earnings and dividends.
Fixed income markets usually will suffer as higher rates tends to translate into lower bond prices.
Inflation is usually a bad thing for retirees. Pensioners spend a higher proportion of their income on food and energy. As this items will cost more in the future, their pension savings will buy relatively less. Hence the importance of anticipation by saving more during the active working life to compensate for the potential loss in purchasing power even if at that time interest rates might be low.
Even if at an individual level inflation has very different impacts, inflation is a sign of a growing economy and is globally positive if anticipated and undercontrol from central bank monetary policy. I kept in mind a quote from a banker colleague that is food for thought “I have met many people earning the same and spending the same. Still, with time, I have seen that some turned richer and some turned poorer”.
Think carefully about your personal situation and be prepared to make the right financial choices when taking into account the impact of higher or lower inflation.
(Article written with assistance from Richard Edwards)
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