What is Inflation? How It Affects Your Money

Inflation is the rate at which the general price level of goods and services rises over time — and equivalently, the rate at which the purchasing power of money falls. When inflation is 3%, something that cost $100 last year costs $103 today.

How inflation is measured in Australia

The Australian Bureau of Statistics (ABS) measures inflation through the Consumer Price Index (CPI) — a basket of goods and services representative of typical Australian household spending. The basket includes housing, food, transport, health, education, recreation, and more.

The CPI is published quarterly. The annual inflation rate is calculated by comparing the current CPI to the same period 12 months prior. Australia's inflation target, set by the Reserve Bank of Australia (RBA), is 2–3% per year on average over time.

What causes inflation?

Economists identify three main drivers:

• Demand-pull inflation: When demand for goods and services exceeds supply — "too much money chasing too few goods." Common during economic booms or periods of high consumer spending.
• Cost-push inflation: When production costs rise — higher wages, energy prices, or raw materials — and businesses pass these costs on through higher prices. The 2022–23 inflation spike was partly driven by global energy and supply chain costs.
• Built-in (wage-price) inflation: When workers expect higher prices and negotiate higher wages, which then increase business costs, which then raise prices again — a self-reinforcing cycle.

How inflation erodes purchasing power

The destructive effect of inflation on savings is often underestimated because it's gradual. At 3% inflation, $100,000 in savings has the purchasing power of just $74,000 in ten years — even if the nominal balance is unchanged.

The table shows the real purchasing power of $100,000 at various inflation rates — i.e., what that money can actually buy.

The RBA's 2–3% inflation target

The Reserve Bank of Australia aims to keep CPI inflation between 2% and 3% on average over time. This target is not a law but a policy framework. Moderate inflation is considered healthy because it:

• Encourages spending and investment (money kept as cash loses value)
• Gives the RBA room to cut interest rates in downturns (harder to stimulate below 0%)
• Allows wages to rise in nominal terms even if real wages are flat

When inflation runs above the target band — as it did in 2022–23 when CPI reached 7.8% — the RBA raises the cash rate to reduce demand and slow price growth. Higher rates mean higher mortgage repayments for variable rate borrowers, which is the primary transmission mechanism.

Inflation and your investments

The real return on any investment is the nominal return minus inflation. A savings account earning 4.5% when inflation is 3% generates a real return of only 1.5%. This is why long-term investors typically seek assets that outpace inflation — equities, property, and inflation-linked bonds — rather than holding pure cash.

Australian superannuation funds have historically returned 7–9% per annum on balanced options — well above long-term inflation averages — which is why compounding super over a working life is so powerful. See our superannuation guide for more.

Inflation and property

Property is often considered an inflation hedge because:

• Rents tend to rise with inflation, maintaining the income yield in real terms
• Property values have historically risen faster than CPI in most Australian capital cities
• A fixed-rate mortgage means repayments stay constant while wages and rents rise — effectively making the mortgage cheaper in real terms over time

However, property is not a perfect inflation hedge. During high-inflation periods, the RBA raises rates, which increases variable mortgage costs and reduces borrowing capacity — often cooling property prices. The relationship is complex.

Related guides: Compound interest · Superannuation in Australia · Saving a house deposit

Sources: Reserve Bank of Australia, Australian Bureau of Statistics CPI methodology, ABS Catalogue 6401.0.