How Does Inflation Affect Your Financial Planning?

We always have a budget for each and every expense be it major or minor. Just imagine a situation where you are saving money for years for a dream of yours and when the time is finally here to get that dream you come to know that the money you have been saving isn’t complete enough.

For example, you wanted to buy a house and have been saving money for years but due to inflation and constant eroding purchasing power of your money, the amount of your savings keep decreasing every year with the constant increase in prices of goods and services- the result: “Your money now isn’t adequate to get you the house you wanted since the period of your savings has increased now along with the rise in the price of the real estate property.

Solution

Financial Planning is the best way in which you as a normal investor can cope with inflation. There are various ways through which you can keep a track of your earnings as well as find out different financial instruments which help you hedge against the uncertainty of price changes and give you the returns you expect as a rational investor for your money.

You can have small budgets through which you can set goals for your dreams and targets, be it saving for marriage, for your loved one, may be to buy a house or gift your partner on her birthday. It is very important for each and every one of us to pay attention to inflation affecting our savings and income along with planning to protect ourselves against the same.

Why is it Important to Control Inflation?

It is of utmost priority that inflation should be kept in check because significant inflation massively harms both the economy and people.

If inflation is high, people get rid of money as fast as possible. So they make bad purchasing decisions, don't save, and don't invest. The delay in collecting taxes means that by the time the government gets its hands on the money it is worthless. And pensioners living off savings find that those savings rapidly become worthless.

Ways to Control Inflation

There are three broad ways through which inflation can be kept in check namely:

1. Monetary Policy: This is the most important measure to control inflation. It is the prime responsibility of the central bank to control the flow of money supply in the economy, this is done by increasing the interest rates.

• Bank Rate – This is one of the primary tools of the central bank to control inflation. An increase in the bank rate makes it expensive for the banks to borrow funds at a cheaper rate from the central bank thus controlling the disposable money with the banks to be used in the form of loan advances.

• Cash Reserve Ratio – Under this method, the central bank increases the reserve ratio which the banks have to keep with them in the form of a reserve thus limiting the availability of funds and thus reducing their lending capabilities

• Open Market Operations – Here the central bank sells / purchases government securities and bonds to absorb excess money circulation from the economy.

2. Fiscal Policy: Fiscal policy includes a reduction in unnecessary expenditure, an increase in taxes, an increase in savings, etc.

3. Other Measures:

• Liquidity adjustment Facility: This facility includes adjustment of repo rate and reverse repo rate.

Repo Rate: Rate at which commercial banks borrow from the Reserve bank by mortgaging securities.
Reverse Repo Rate: Rate at which RBI borrows from commercial banks.

• Market Stabilization Scheme: This is a measure under which reserve banks issue government securities to absorb excess liquidity. These securities are issued in consultation with the ministry of finance and interest on the same is paid by the finance ministry.

• Credit Rationing: Here the reserve bank restricts the flow of credit to certain sectors in the economy. Here the central banks decide a ceiling limit on the availability of credit facilities to a particular sector based on CRAR ratio (capital to risk-weighted asset ratio) where the capital is available as a percentage of risk-weighted assets.