GDP and inflation are key markers of a nation’s economy. Slow and steady growth can lead to greater profits, more jobs, and higher wages. But when both increase too quickly, managing your finances can become stressful. What exactly are GDP and inflation, and how do they impact you?
📈 Defining GDP and inflation in plain English
GDP stands for gross domestic product, referring to the market value, in dollar terms, of a nation’s total goods and services produced.
Inflation, on the other hand, measures the average increase in prices of a nation’s goods and services, usually over a year.
💼 What’s the relationship between GDP and inflation?
The relationship between GDP and inflation is complex. An increase in GDP often coincides with an increase in inflation. A growing GDP indicates a growing economy with low unemployment and higher wages, which increases household incomes. This creates greater demand for goods and services, and if demand grows faster than supply, prices rise. Slow, steady growth in GDP, with inflation around 2-3% per year, is beneficial. It indicates providers of goods and services are making decent profits, creating jobs, and paying better wages, which improves the standard of living for everyone.
💰 What’s monetary policy?
Central banks use interest rates to manage inflation - this is what’s called monetary policy. In Australia, our central bank is called the Reserve Bank of Australia (RBA).
When inflation is high, the RBA can decide to increase the cash rate. When the cash rate increases, the cost of borrowing money goes up, which can help to curb spending and, in turn, reduce inflation.
🛒 What does inflation mean for your finances?
When inflation rises, essentials like groceries and energy bills become more expensive, leading to an increased cost of living. If the RBA also increases the cash rate, this often leads to higher interest rates on loans and mortgages, which can further add to cost-of-living pressures.
Inflation also impacts your savings. This is because the money you have today will be worth less in a year’s time if the price of goods increases. To combat this, you could look to put your savings in a high interest savings account.
💸 How to manage inflation
When inflation and interest rates are high, your debt can get more difficult to manage. If you have multiple loans, credit cards, and buy-now-pay-later accounts, you could consider debt consolidation. This can help you lower your monthly repayments and often helps to reduce the overall interest cost of your debt.
On the other hand, when inflation is under control, your money goes further. If you’re in debt, this could be a good time to focus on paying it down, starting with overdue accounts and more expensive debt.
💡 The bottom line
Managing your money proactively during different economic conditions can help you stay on top of your financial goals.