The effects of inflation...

High inflation makes it difficult to accurately evaluate the changes in relative prices on which households and firms base their consumption and investment decisions. It randomly makes people richer or poorer, depending on the condition in which they happen to find themselves when inflation strikes. It increases interest rates, thus making investments more expensive, and in the long term, it correlates to poor economic growth: we will all be sharing a smaller pie.

...on savings

Inflation hits the savings we have built up over time and decreases their value and purchasing power: we can't buy as many goods and services with the same money. Our earnings' real value will also fall, unless they are increased to match inflation.

...on loans

It isn't just earnings and savings whose real value decreases due to inflation, but also loans. Those who have taken out a fixed-rate loan, and who are therefore repaying it in fixed monthly instalments, benefit from inflation, as it reduces the real value of the money owed; in addition, the amount of each instalment remains unchanged, whereas our earnings will sooner or later increase with inflation.

For variable-rate mortgages, on the other hand, the effects of inflation are less significant, and potentially detrimental. That is because inflation usually correlates with increased interest rates, which in turn cause a rise in the amount to be paid for each instalment, so the real value of the money owed does not change (in fact, if our earnings don't increase immediately alongside inflation, we may find ourselves poorer, at least for a short while).

Finally, for those who are about to take out a loan, whether variable- or fixed-rate, an increase in inflation and interest rates leads to increased borrowing costs (and in the case of mortgages, in higher amounts for each instalment).

In short, we might say that inflation isn't a problem for those who have already taken out a fixed-rate loan, whereas it is usually a disadvantage for those who are going to take out a loan.

The Government is the biggest debtor. Every year it issues bonds in order to borrow billions of euros to cover the difference between revenues (tax and levies) and expenses (public spending on education, defense, healthcare, pensions and so on), as well as to pay back the bonds that have reached maturity. Therefore, as far as fixed-rate public debt is concerned, inflation benefits the Government as it reduces the real value of the loan to be paid back.

Nevertheless, inflation can be detrimental for the Government too in the long run: for instance, public expenses such as pensions, goods and services, and interest on debt will increase.

...and on financial investments

As far as our financial investments are concerned, the situation is reversed: for every debtor who benefits from inflation (as is the case for fixed-rate loans), there is a creditor who loses money, and the other way round!

Therefore, those who purchased a fixed-rate bond, thus becoming creditors of the Government or of a firm, will be penalized by inflation. As interest rates rise, the price of their bond will fall to reflect the smaller real value that the coupons and the principal will have at maturity. On the other hand, those who have invested in variable-rate bonds, which are indexed-linked to inflation or market rates, will be protected if inflation rises: the increased value of the coupons or the principal paid back at maturity will compensate - completely, or in part - the loss of the purchasing power of money caused by inflation.

The increase in interest rates brought about by inflation may also reduce the value of other investments, such as stocks (but investment in real estate is not protected either). In this case, the correlation between interest rates and the value of such assets may be complex: we have explored it in detail in this article.

Finally, here is one last way that the situation is reversed compared with that of debtors: those who decide to invest part of their savings, but haven't done so yet, will find a greater earnings potential than before, due to the higher interest rates correlated to inflation.

Inflation is an unjust tax

Inflation is said to be 'an unjust tax', so let's see why. First of all, it is called a tax because it reduces the amount of goods and services that people can buy, but most importantly, it is unjust because it does not affect everyone to the same degree.

Typically, inflation hits the less well-off the hardest, as those who are worse off use up a larger share of their income to purchase the bare necessities (groceries, energy and transportation), which are often subject to the greatest increases. Generally speaking, the increased cost of living could make it impossible for income to cover basic expenses, forcing those who are worse off to dip into their savings (provided they have any).