Why my dad is being hit hardest by inflation

Inflation remains a hot topic here in the UK. The latest numbers out last week showed CPI had risen by 5% over the year.  This is only 3% above the Bank of England’s target rate. If inflation remains at this rate for the next 5 years, the buying power of £100 today will fall to £78.35. Ouch! The words of John Maynard Keynes immediately spring to mind: “The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

I thought it might be interesting to see what the actual experience of inflation was for UK citizens. Obviously, the basket of goods will differ between a student or a pensioner and hence their respective experience of inflation can be very different. Warning – I had to make a few assumptions/guesses along the way (as any good economic analysis inevitably does).

I have split up the population into four highly simplistic categories; student, parent of a young family, baby boomer, and a pensioner. To assist my guess work, I had a few people in mind. These being: my brother’s girlfriend (uni student), my uncle (parent of a young family), my old man (baby boomer b. 1956), and my granny (age 78). From this highly scientific reasoning I came up with the following inflation basket weights.

Category UK CPI Student Parent of a young family Baby boomer Pensioner Average of sample
Food 12% 15% 15% 10% 20% 15%
Alcohol & Tobacco 4% 10% 2% 5% 0% 4%
Clothing 6% 3% 5% 5% 5% 5%
Housing 13% 7% 20% 15% 20% 16%
Furniture 6% 0% 5% 10% 5% 5%
Health 2% 1% 3% 3% 15% 6%
Transport 16% 18% 15% 20% 5% 15%
Communication 3% 5% 2% 3% 4% 4%
Recreation 15% 10% 15% 10% 10% 11%
Education 2% 10% 10% 0% 0% 5%
Restaurants 12% 15% 5% 13% 5% 10%
Miscellaneous 9% 6% 3% 6% 11% 7%

 

Interestingly, even though it is a very small sample, the average weights of the four people comes very close of the official UK CPI weights. The biggest difference is recreation (the sample proportionately spends less than the official basket) and health (where granny’s basket of goods is weighted 15% towards health).

Let’s have a look at what the inflation rate was over the past year for the categories that make up the UK’s basket of goods.

Food 5.00%
Alcohol & Tobacco 9.10%
Clothing 3.60%
Housing 9.10%
Furniture 5.70%
Health 3.00%
Transport 7.70%
Communication 4.80%
Recreation -0.50%
Education 5.10%
Restaurants 4.50%
Miscellaneous 2.80%

 

It is now possible to calculate inflation across the categories. UK inflation is 5.0%. Inflation for a student came out at 5.4%. Inflation for a parent of a young family is 5.3%. The baby boomer category came out at 5.5%. Pensioner inflation was calculated to be 4.8%. From this analysis it appears baby boomers are being hit the hardest by inflation. If inflation stays at its current rate for my old man, in 2024 he will find £100 will lose half its value and will only purchase £49.86 worth of goods and services.

What is particularly interesting is that UK pensioners currently make up 16% of the population. This is forecast to grow to 23% by 2035. This demographic trend may have a substantial impact on inflation going forward. As the UK population ages, a greater proportion of the population will be minimising their consumption to save for retirement. This is a deflationary force. Categories like recreation, restaurants, and alcohol & tobacco will likely fall as a proportion of the consumer basket.

On the other hand, the workforce will become less efficient as workers retire. Highly skilled workers will become more scarce, suggesting employment costs will rise. Production of goods and services and productivity will fall. This is an inflationary force. Categories like health and housing (which incorporates utility bills) will likely grow as a proportion of the average UK consumer’s basket.

Sir Mervyn King blames the VAT increase and higher import and energy prices for high UK inflation readings. It is nice to be able to look through these effects if you are setting monetary policy, less nice if the rising costs of these items are eating into your retirement nest egg. With the BoE bank rate at 0.5% and unlikely to rise anytime soon, it is hard to find a secure investment which will compensate for the current elevated level of inflation.

It is rumoured that if you place a frog into a pot of water and slowly increase the heat to boiling, it will not feel it. With the BoE embarking on another round of QE, the water could reach boiling point very soon for UK savers.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Discuss Article

  1. Damien Fahy says:

    While I appreciate this is all based on assumptions but as your dad ages he will slowly move towards the pensioner inflation rate as his spending patterns change.

    All things being equal his inflation rate will therefore fall.

    Meanwhile, the parent with a young family will slowly move towards dad’s current so their spending will more likely start to alter. Consequently their inflation rate will likely increase.

    Plus they will be shouldering more of the tax burden to fund dad’s retirement.

    Not so sure I feel so sorry for dad.
     

    Posted on: 22/11/11 | 12:01 pm
  2. Gareth says:

    “the water could reach boiling point very soon for UK savers.”
    And then what?  Savers will start spending or investing in real (productive) assets instead?  Which might… reduce unemployment?  Isn’t that the point?  Why should we cry for savers with 8%+ unemployed?

    Posted on: 22/11/11 | 12:08 pm
  3. WellRed says:

    Gareth,

    Investment is the other side of saving. Without savings, there is no investment in real assets.

    What I take issue with is this “On the other hand, the workforce will become less efficient as workers retire. Highly skilled workers will become more scarce, suggesting employment costs will rise.”
    Producitivity is a function of skill and energy. I am sure you work in an office therefore should know that the tenured guys exert little to no energy (and I would argue that their skill level is questionable as well). Having them retire to allow for fresh people with energy and new ideas would probably increase productivity, despite what the textbooks may say about human capital.

    Posted on: 22/11/11 | 1:47 pm
  4. Justin Pugsley says:

    Is inflation all part of rebalancing the economy?

    As nominal GDP rises the percentage of GDP/debt should fall or at least be blunted, which will look like the UK is getting on top of its debt problem, even though it is effectively robbing investors. 

    Secondly, inflation which is rising faster than wages is hurting the consumer economy forcing firms that want to grow to look to export markets. It’s typical for export orientated economies to suppress domestic demand somehow to achieve that objective.  

    Posted on: 22/11/11 | 2:23 pm

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