Why does your money lose value even if you don't spend it?

Picture this - in 2010, you could buy about 4 cups of coffee with $5. But in 2026, that 

number goes down to less than 2. The same cup of coffee now costs 2 dollars more. 

Now this raises the question - why?

What this tells us is that although cash balance stays the same, purchasing power is 

reduced. This is because of inflation. Inflation is the sustained increase in the general 

price level of goods and services in an economy over time, which results in a decrease 

in the purchasing power of money. 

Demand is usually higher than supply, so prices increase. Things cost more to produce 

(higher wages, fuel, materials), so sellers charge more. More money in the economy 

means each dollar is worth a bit less. Shortages or disruptions make certain products 

harder to get, pushing prices up. As people earn more and spend more, businesses 

raise prices to match demand. This is the cycle that causes inflation to occur 

Nevertheless, not all inflation is harmful. While high inflation is considered negative, 

many economies strive for low inflation, as it is often beneficial. 

This is because if prices are slowly rising, people are more likely to spend or invest 

instead of holding cash. Businesses can raise prices gradually, which helps them grow 

and pay higher wages. Wages tend to increase over time in a healthy economy, so 

inflation matches rising incomes. It reduces the risk of deflation, where people delay 

spending and the economy slows down. It helps debt borrowers, because they repay 

loans with money that is worth less over time. It signals economic activity and demand, 

which supports production and jobs, as well as investments towards the country 

With inflation, there’s also an impact to income. Let’s suppose that one earns about 

$100,000 per year. If the inflation rate next year increases by 5%, but the income only 

increases by 3%, then the person’s real income will decrease by 2%. Therefore, even if 

someone’s salary increases, they are not necessarily better off, because if inflation rises 

faster than income, their real purchasing power still falls and they can afford less than 

before. 

Additionally, inflation also has an impact to savings. Let’s again imagine that a person 

has $100 stored in their savings account. If the inflation next year increases by 5%, but 

the interest rate is only 3%, then the real value of the savings decreases by 2%. 

Therefore, even if someone’s savings remain the same in amount, their real value 

decreases over time because inflation reduces how much those savings can actually 

buy. 

Central banks also manage inflation to keep the economy stable. They control interest 

rates. If inflation is too high, they raise interest rates. People would borrow and spend 

less, thus prices slow down, reducing inflation. If inflation is too low, they lower interest 

rates. People would borrow and spend more, thus prices increase, increasing inflation 

to the desired level required. 

Central banks also control the money supply in the economy. If there is a higher supply 

of money in the economy, this leads to higher inflation. If there is a lower supply of 

money in the economy, this leads to lower inflation. The main goal of central banks is to 

keep inflation low and stable. 

 High inflation is bad for the economy, but so is no inflation or decreased inflation. Why 

is this so? 

Deflation is the sustained decrease in the general price level of goods and services over 

time, which increases the purchasing power of money. As mentioned before, deflation 

causes people to delay spending, resulting in the economy slowing down. 

This is harmful because people delay purchases because prices are expected to fall 

further, therefore demand drops. Businesses sell less, so revenue falls. Hence, they 

reduce production, wages, or terminate jobs. Unemployment rises, reducing overall 

income and spending in the economy. Lower demand forces businesses to keep 

lowering prices causing deflation to worsen. Debts become harder to repay because 

money is gaining value. Thus, real debt burden increases. Economic growth slows due 

to reduced spending and investment. 

A good example of why deflation is bad is Japan’s ‘Lost Decades’. Japan's deflation 

spiral began when a massive late 1980s asset bubble, caused by negative speculation 

in property and stocks, burst after the Bank of Japan hiked interest rates in 1989, wiping 

out trillions in asset value. Banks had to deal with massive amounts of loans and rather 

than writing them off, kept supporting failing firms to hide the damage. Credit froze, 

businesses and households stopped spending and focused entirely on paying down 

debt, demand collapsed, and prices started falling. Once deflation set in, consumers 

delayed spending expecting cheaper prices tomorrow, firms cut prices to survive, wages fell, and demand dropped further. The Bank of Japan reduced rates to zero but nobody wanted to borrow, and repeated government stimulus packages piled up debt without breaking the cycle. The result was two lost decades of near-zero growth and stagnant wages. 

In conclusion, inflation isn’t necessarily negative, but can prove to be harmful when it is 

extremely high.