An economy is the flow of money and the direction of money flow between people, banks, and businesses. When trying to research for yourself, google produces a lot of sites with technical, economic terms like supply and demand and economic growth, stagnation, inflation, and recessions. What does that mean in real life? How does the economy affect me?
It’s easy to feel detached from the economy; for those who run small businesses, you might be more aware of economic conditions and economic activity, but it can be distant and detached for regular people. We heard a lot about the economy during the coronavirus pandemic, but it was frustrating and foreign to many people. Meanwhile all around us we saw job loss, shortage in supermarkets, businesses having to close; It clearly affects us all.
This post looks at 6 economic situations to show you precisely what happens to yourself for your own money under different economic scenarios.
The 6 scenarios covered are:
- What happens to my money when inflation is high?
- What happens to my money when inflation is stagnant?
- What happens to my money in a recession?
- What happens to my money in a time of growth?
- What happens to my money while interest rates are high?
- What happens to my money while interest rates are low?
A quick overview of some of the keywords we’re using. The rest of this post will explain intuitively what all these economic situations mean for you.
Inflation is the decrease in ‘purchase power’ of money. Interest rates are the amount it costs to borrow money, or the payments you get if you’ve lent money. Growth and recession are two forms of the economy that completely change all economic aspects of life we interact with (money, businesses, jobs etc). Gross domestic product is how we measure this. When I mention ‘cash’ in these descriptions below, I’m talking about money either in cash form, or money in digital form sitting in a bank account. I have other posts on these key economic concepts linked below in the article.
This post is to give a general sense of information only. It’s NOT financial advice.
What happens to my money when inflation is high?
High inflation means money reduces in value relative to items (or items increase in price relative to the value of money).
- Cash loses value fast- it’s more cost-effective to buy things you need because if you have £100 in the bank today and that is enough for a winter coat, the relative cost of the coat compared to the money will go up. Next year that coat might cost £102, and you can no longer afford it. The money you had in the bank used to be worth a coat, now it’s not worth a coat. £100 in the banks today might only be worth £85 of real value in the future. So generally, more people spend cash to buy things or investments under high inflation.
- Investments. High inflation is not necessarily good for the value of investments, but investments will not devalue as fast as cash. You might still make money off them, even if that money you make buys you less stuff.
- If you own a house, the value of your house will go up (unless there is something else happening specifically in the housing market)
What happens to my money when inflation is stagnant?
- When inflation is stagnant, the value of cash is not reduced. It’s not particularly good, but its an ok time to have money in cash
- The value of your investments will go up as you’d expect, it’s not particularly affected
- Your house price will also not rocket up but be ok and relatively stable
- Jobs- it’s not the biggest affecter of jobs
How does the economy affect me in a recession?
- Your money becomes more valuable in liquid form (i.e. cash). That is not to say that suddenly cash is worth double, but people want cash in recessions. It’s harder for people to get loans, so in a personal way and for firms, money in a bank is more valuable. Without personal loans, people might use credit cards for essential spending and build up debt which could have a terrible impact over time. If you have lots of cash, you can do well by buying things that are going cheaply because often many people have to sell things at low prices to generate cash during recessions
- Investments will drop in value- you will make a bad deal if you sell them. Hence, you need to leave them in place until after the recession if you have enough cash to last you throughout. If you sell investments in a recession because you need the money, you’ll have lost out.
- In a recession or economic downturn, it’s tough to get mortgages. House prices drop. If you already own a house, it might be that mortgage prices drop, which could be good. If you have cash (or a huge deposit), you can get a good deal when buying.
- Job security is low- unemployment rises during recessions, so if you’re lucky to have great work and if you’re unlucky, hopefully, you’ll have savings because it’s hard to get loans, and few companies will be hiring. This is a huge problem. Without jobs, governments have to become more involved. A government might develop a policy to increase subsidies for public health to those without health insurance. This is to afford primary health care, a big problem in the United States.
How does the economy affect me in a time of growth?
- In a time of growth, there are many opportunities to make money- can cash is not an effective way. In times of growth, inflation is usually high, so you can see what that means above.
- During times of growth, your investments will be massively increasing in value.
- In times of growth, it’s easier to get loans and mortgages, even though house prices are increasing. Without fear of a financial crisis, people are much more confident in lending.
- Jobs are plenty in times of growth, and many opportunities exist. You don’t have to worry as much about cuts and redundancies- the job market is secure and also growing.
How does the economy affect me while interest rates are high?
- High-interest rates means it’s good to ‘lend’ money rather than sit on it. So having money in a bank account will earn a better return than when interest rates are low, and that’s good.
- While interest rates are high, it’s a good time to invest money, not borrow money
- High-interest rates means borrowing money is expensive, which means mortgages are likely to be expensive. Banks will want to sell them because they’ll make a good profit- but the total amount you pay back will be very high.
- Generally, interest rates are a sign of good economic situations, which is good for job availability, but they’re not super linked
For more about how interest rates work, you might enjoy this post: How does the Bank of England control Interest rates?
How does the economy affect me while interest rates are low?
- When interest rates are low, money in the bank isn’t earning you anything; it’s just losing value.
- It’s an excellent time to have money in investments- or instead money in investments is better than money in the bank because at least they are still earning you returns
- Interest rates are a piece of economic policy set by the central bank (e.g. Bank of England or federal reserve in the united states) that can signal economic trends for the future.
Conclusions and a bit more info
Hopefully, you can see here and in the figures how these economic environments might affect your money and your purchase power over time. This is a brief overview post, and I hope it is helpful for an impression. To understand the mechanisms of what is happening and why these things are true, check out my other posts: