This blog post examines how inflation affects currency value, income, and perceived living costs, and how it alters our current lives and future choices through specific examples.
There was a time when you could ride the bus for 100 won
From a single potato bought at the market, to a notebook chosen at the stationery store, to a cup of coffee at a cafe—everything we pay for and use has a price tag. We also pay when getting a haircut or seeing a doctor at the hospital. Collectively, we call all these costs people bear in daily life the ‘price level’.
In the 1970s, Seoul city bus fares were less than 100 won. But now it easily exceeds 1,000 won. Is it because buses today are much better than in the past? Or is there another reason? Generally, prices tend to rise over time and rarely fall. Even though Choco Pie, once the size of an adult’s palm, has shrunk to the size of a child’s palm, its price has actually increased. Income, or monthly wages, either stagnates or increases slowly, while prices keep rising. This phenomenon is a sensitive and crucial issue for individuals and simultaneously a core factor driving the entire economy.
The price of each commodity that makes up the overall price level is determined by supply and demand, an indispensable concept when dealing with a market economy. When the quantity of goods is limited but many people want to buy them, prices rise. This is why companies sometimes release ‘limited edition’ products for sale. Even if they deliberately reduce production and set a high price, the product will sell if many people desire its scarcity. Conversely, if the market is flooded with goods but few people want to buy them, prices fall.
However, supply and demand aren’t the only factors affecting price. Conversely, changes in price can also alter supply and demand. If the number of cafes in a specific area increases, price competition ensues, driving down the price of coffee. If the price of coffee drops from 5,000 won to 2,000 won, more people buy coffee. This is because the reduced cost makes it easier for them to open their wallets. This is an example of demand increasing as the price falls. Conversely, if the price of cigarettes rises from 3,000 won to 5,000 won, the relative value of each cigarette increases, and more people resolve to quit smoking. Ultimately, demand decreases as the price rises. However, because cigarettes are a highly addictive product, they exhibit a unique pattern: demand may drop immediately after a price hike but often increases again after a certain period.
Why you can’t just be happy when your bank balance grows: the inflation rate
When prices rise, it means the value of money falls. A child who receives 10,000 won as New Year’s pocket money rejoices as if they’ve become rich. That’s because they can buy quite a lot of things at a stationery store or supermarket with that money. But will that child feel the same satisfaction with 10,000 won when they become an adult? As an adult, 10,000 won is worth about one meal. This shows that the monetary value of 10,000 won—in other words, the purchasing power of money—has significantly decreased compared to the past.
‘Declining monetary value’ doesn’t simply mean you can buy fewer items with 10,000 won or that chocolate pies have gotten smaller. Suppose you deposit 10 million won into a bank account with a 10% interest rate. After one year, 1 million won in interest accrues, bringing the total to 11 million won. On the surface, this clearly represents a gain of 1 million won. However, the true value of this money can only be accurately assessed by considering the inflation rate.
If prices hadn’t risen, the depositor would have gained 1 million won. But if prices have increased, the story changes. The phrase ‘10% inflation rate’ means that the goods and services you could buy with 10 million won today will require 11 million won a year later to purchase the same amount. In other words, even if 10 million won deposited grew to 11 million won after a year, the real value of that money is equivalent to 10 million won from a year ago. The inflation rate has essentially eroded the interest rate.
Inflation directly means a decline in the purchasing power of money. Put simply, the quantity of goods one can buy with the same amount of money decreases, which leads to a decline in the value of money.
We can consider annual salary increases in a similar context. Even if a salary rises by 5%, if prices increase by 10% during that period, the person’s real salary—their actual purchasing power for goods and services—has effectively decreased by 5%. For someone whose salary was already cut due to poor performance, inflation becomes a harsh double blow.
When the term ‘real’ appears in economic articles, it refers to figures that account for inflation. Only by reflecting inflation can we accurately gauge actual value. The opposite concept of ‘real’ is ‘nominal,’ which means judging based solely on the numerical value itself, regardless of actual worth. This distinction is used in expressions like real interest rate versus nominal interest rate, and real economic growth rate versus nominal economic growth rate.
Prices have a real and direct impact not only on individuals but also on households and businesses. This is why the government has designated the Bank of Korea as the dedicated institution for price management. The ultimate goal the Bank of Korea seeks to achieve through monetary policy is also the stable management of the inflation rate. Therefore, it is necessary to pay more attention to the inflation rate than to the current price level. Generally, when the economy grows, prices also rise. If we dream of a future where we eat well and live well, some degree of price increase is also something we must accept. What is important is ‘how much’ prices rise, that is, the magnitude of the increase.
Price Index for Households and Price Index for Businesses
“The government says ‘low inflation’… yet food price inflation ranks 2nd in the OECD” (Channel A, 2019.02.23.)
Let’s pose a practical question. While the price situation from the second half of 2018 to the first half of 2019 was described as ‘low inflation,’ people felt their living expenses actually increased and their quality of life declined. What could be the reason? The answer lies in how prices are measured.
The Consumer Price Index (CPI), the government’s primary price index, selects about 500 items and calculates an average based on price changes surveyed in households across approximately 40 cities nationwide. In this process, if the prices of items not included in the survey fluctuate significantly, the perceived cost of living can change for people, even if the index itself shows no change. A prime example is housing prices. Monthly rent and jeonse deposits are included in the surveyed items, but the actual purchase price of a home is not reflected in the CPI. Consequently, even when apartment prices rise by hundreds of millions of won, the CPI may show little change.
At that time, oil prices were falling while agricultural product prices were rising. Households not using cars might not have felt the drop in oil prices, but they would have clearly noticed the rise in agricultural product prices while shopping. This is why the government’s announcement that ‘prices are low’ often doesn’t resonate in everyday life.
“Core inflation also surges 4.8%… Prices to stay in 5% range until early next year” (Asia Economy, 2022.12.02.)
Commodities like crude oil and agricultural products are closely tied to daily life yet highly susceptible to external price fluctuations. Oil prices fluctuate significantly based on economic conditions or international political situations, while agricultural product prices also change rapidly due to natural environments like typhoons or droughts and crop yields. These factors are difficult to control but are directly included in general prices, making them highly likely to distort overall inflation.
For this reason, the indicator ‘core inflation’—calculated by excluding volatile items like oil and agricultural products—frequently appears in economic articles. An increase in core inflation can be interpreted as indicating a general upward trend in overall prices. Conversely, even if overall prices rise temporarily, stable core inflation suggests the increase is due to temporary factors.
To reduce the gap between the Consumer Price Index (CPI) and perceived prices, the government also manages supplementary indicators: the ‘Living Expenses Index’ and the ‘Fresh Food Index’. The Living Expense Index measures prices for about 150 essential daily goods frequently purchased by people, such as rice, cabbage, and beef. The Fresh Food Index is calculated based on about 50 items, like vegetables and fruits, whose prices fluctuate significantly with seasons and weather conditions. Therefore, when encountering news articles stating that prices have risen, it is necessary to first examine which price index standard the report is based on, rather than blindly criticizing the government.
“China’s ‘D Fears’ Intensify as Producer Prices Remain Negative for Second Consecutive Month” (Financial News, 2022.12.09.)
Households are not the only entities driving economic activity. Businesses are also crucial economic actors. Unlike households, businesses rarely purchase snacks, vegetables, or pork belly directly from supermarkets. Consequently, the household ‘shopping basket price’ is not a suitable benchmark for businesses to gauge inflation. This necessitates separate price indices tailored for businesses. These are the Producer Price Index (PPI), which measures price fluctuations for goods traded between businesses, and the Import-Export Price Index, which reflects price changes for goods traded through exports and imports.
Prices from the producer’s perspective are also critically important. Producer prices ultimately influence commodity prices, affecting consumer prices and the broader economy. The headline of the previous article reflects concerns arising from producer prices falling for two consecutive months. This reflects worries about deflation, where falling prices coincide with an economic downturn, and simultaneously expresses concern about the impact of China’s economic slowdown on our economy. China is one of Korea’s largest export destinations, so an economic downturn there can directly impact the entire domestic economy.
Carefully examining these price changes not only helps us understand the current economic situation but also aids in predicting future economic trends. It is no coincidence that the government has established a dedicated institution, the Bank of Korea, to manage prices. Prices carry meaning beyond mere numbers; they are crucial indicators that simultaneously illuminate the direction of our lives and the economy.
