Inflation, deflation and stagflation Q&A

1. What is inflation?

Inflation means an increase in the price of goods and services. If the price of equivalent goods or services rises, the purchasing power of money decreases. Inflationary currency depreciation can have several causes:

• If the demand for certain goods grows faster than companies supply them, the surplus demand leads to a rise in prices and thus to inflation. Companies can also raise prices and thus increase profits if there are no alternative products on the market.

• If, for example, prices on the international commodity markets rise, this is referred to as cost push inflation. In some cases, they can be passed on to end consumers very quickly (e.g. petrol or heating oil prices). In the case of foodstuffs, this effect occurs with a delay.

• If a central bank (in Switzerland, the Swiss National Bank (SNB)) pumps money into the economy faster than the growth of the real economy requires, the available money supply inflates. This means that it loses value. The SNB can pump additional money into the economy if economic growth is too slow. This leads to inflation. However, it also stimulates demand and thus the economy as a whole. This is because consumers will buy as much as possible at the lower prices. Companies, meanwhile, will invest in capital goods before everything gets more expensive.

A rise in prices restricted to certain industries or due to an increase in VAT is not considered inflation. Inflation is measured using a shopping basket. This basket is intended to reflect household expenditure in a representative way.

However, its composition is open to question. In the Swiss Consumer Price Index (CPI), for example, rental price developments are weighted at around 25.5%. However, the index does not account for the price increase of the properties themselves. Health insurance premiums – which make up a considerable portion of a household's budget – and other social security premiums are not included in the price index either.

2. What is the difference between inflation and deflation?

The opposite of inflation is deflation. This means prices fall and purchasing power increases. As a result, you get more for your money during deflation.

3. What does stagflation mean?

The combination of insufficient economic growth and inflation is called stagflation. Indications of insufficient economic growth are high unemployment and underutilized productive capacity. Western industrial societies last experienced stagflation in the 1970s due to the oil price shock.

4. Are we currently experiencing inflation?

Some inflation is good because it oils the wheels of the economy. The European Central Bank (ECB) has therefore set an inflation target of 2%. The SNB is officially aiming for an inflation rate of less than 2%.

In April 2022, the Swiss CPI posted a 2.5% year-over-year increase. This means that the current inflation rate is too high. Compare that to July 2008, during the financial crisis, when the Swiss inflation index rose to 3.1%.

The reasons for these high inflation figures are as follows:

• Suspended trade relations with Russia

• Disruptions to the supply of raw materials from Ukraine due to the war

• Global supply chain issues

• High levels of consumption in Western industrialized countries (pent-up demand after the coronavirus pandemic)

In short, we are currently in an inflationary phase. However, the Swiss National Bank does not as yet see the higher inflation index as a reason to intervene. It expects inflation to slow to around 1% by the end of 2022.

5. What happens to my mortgage during inflation?

What does 2% inflation mean for people in Switzerland? If you keep your savings for 10 years without earning interest, you will lose 21.9% of your purchasing power. From the point of view of savers, inflation is therefore equivalent to expropriation.

The converse is true of a loan. Borrowers benefit from inflation. The longer the loan term, the better. This is particularly true of long-term mortgages. A 20-year mortgage that has matured still has a real value equal to 51.4% of the original loan at an average of 2% inflation.

6. Is inflation good for borrowers?

In principle, all borrowers benefit from inflation provided that their income is sufficient to meet interest and repayment obligations.

Rampant inflation, however, can spell a debt trap for people without financial reserves: if inflation is too high, central banks slow down the growth of the national economy by reducing the money supply.

This leads to restructuring in the real economy and thus to a temporarily higher unemployment rate. Debt associated with job loss can quickly lead to over-indebtedness.