What is purchasing power?
Learn what purchasing power is and how inflation affects what you can afford.
In lesson 1.1.4, you learned that inflation means money losing value: when products and services become more expensive, your money buys less. For your own finances, inflation often means lower purchasing power.
What is purchasing power?
Purchasing power refers to how much you can buy with your money. When inflation is high, your purchasing power can fall. Products and services become more expensive, and if your income does not rise along with inflation, you can afford less.
Purchasing power and inflation
At first glance, low inflation seems better for your wallet. Deflation might sound even better: prices fall, your money becomes more valuable and you can buy more. In that case, your purchasing power rises.
Unfortunately, low inflation and deflation are usually not good for the economy in the long run. Think about what you would do if prices kept falling. You might postpone purchases, hoping things will become even cheaper later. If many people do this at the same time, economic activity can slow down significantly.
That is why central banks aim to keep inflation at around 2% — not too high, not too low.
How the war in Ukraine drove up inflation
You may remember the energy crisis of 2022 and 2023. Gas and electricity prices rose sharply due to the war in Ukraine. Some households received extremely high energy bills, leaving them with less money for other expenses.
Other products also became more expensive, as some producers passed on part of their higher energy costs to consumers. The result: high inflation.
Fig. 1 The decline of the euro's purchasing power over the years.
Inflation and savings
High inflation can also cause your savings to lose value more quickly. This happens when inflation is higher than the interest rate you receive on your savings account.
For example, imagine you earn 2% interest on your savings over a year. But average inflation that year was 4%. In real terms, your savings have decreased in value.
Different for everyone
How much inflation affects your purchasing power depends on your personal situation. Sometimes only certain products become more expensive — for example, bananas. If you regularly buy a lot of bananas, you will feel that price increase more strongly than someone who never eats them.
So when you read in the news, “Inflation was 3.3% last month,” it does not automatically mean you had exactly 3.3% less to spend compared to the same month last year. The impact of inflation on your purchasing power depends on your spending pattern.
Individual differences in purchasing power
In 2022 and 2023, inflation was high for several months due to energy prices. But not everyone faced extremely high energy bills. If you had an energy contract with a fixed rate, you were probably less affected.
Takeaways
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High inflation can reduce your purchasing power.
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If inflation is higher than the interest on your savings, your savings lose value in real terms.
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The exact impact of inflation on your purchasing power depends on your personal situation.
When does your purchasing power fall? (multiple answers possible)