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Why does inflation need to come down?

Inflation continues to remain high. What does that mean for society and what can we do about it? 

High inflation means less purchasing power

Households are the first to feel inflation in their wallets: you can buy less with the same amount of money. At an inflation rate of 10%, a carton of yoghurt that cost €2 last year will cost €2.20 this year. As the prices of everyday products suddenly rise sharply and lower-income households have few buffers, these households are particularly affected by high inflation.  

Pensioners have less to spend

Pension funds would prefer to increase the benefits they pay out every year in line with price increases caused by inflation. This is referred to as index-linking. Unfortunately, however, this is not always possible. Pension funds are only allowed to increase benefit payments if they have sufficient assets. This is by no means always the case. As a result, high inflation means you can buy less with the same pension than before.

Businesses also suffer from inflation 

Steep price increases create uncertainty about the costs and revenues of long-term projects, such as housing construction or road building. At the time of investment, a project is estimated to cost a certain amount of money. If construction takes a long time and there is high inflation, the true cost could end up being much higher. Long-term high inflation can thus create uncertainty for companies, which means they will be less willing to invest in long-term projects.  

To what extent can the government step in?

As we saw during the energy crisis following Russia's invasion of Ukraine, struggling households and businesses can ask for government support. This may lead to a deficit in the national budget. Moreover, if such support is not sufficiently targeted towards the groups most in need of financial help, there is a risk it will actually increase economic demand and reinforce inflation – the opposite of what it was supposed to do.

Together we need to get inflation down 

Long-term inflation is undesirable for households, businesses and the government alike. At the Nederlandsche Bank, we work with the European Central Bank to raise interest rates. Higher interest rates, combined with a government staying within its budget and employers and employees not raising wages or profits too quickly, can ensure that inflation falls back to the 2% target in the longer term. 

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