The cost of living explained

You will be aware that the cost of living is increasing, but what does it mean, why is it happening, and what can you do? Here we explain.

The ‘cost of living’ is a frequently used term that refers to the amount of money people need to cover basic expenses, such as housing, food, energy bills, and healthcare.

It is calculated differently depending on which country you live in but, generally speaking, the government or central bank monitors the cost of the things an “average” person would typically spend their money on each month and, if this “basket of goods and services” increases in cost, then the cost of living is deemed to have risen. 

Across Europe, one of the biggest factors driving the increase in the cost of living is rising energy prices which is a result of the ongoing war in Ukraine and its impact on the price of natural gas and oil. This has increased costs for energy companies that produce electricity, petrol, and diesel products and so prices have gone up. This has resulted in the amount the “average” person spends each month on energy for their homes, and fuel for their vehicles, rising too. As energy is also used by the businesses we buy goods and services from, their costs have also increased which has resulted in the price of things we purchase rising as they pass on their increased costs.

However, rising energy prices are not the only thing increasing the cost of living. Ukraine is a major grain supplier, so a shortage of grain has pushed up some food and drink prices, and global supply chains are still facing disruption following the pandemic which is increasing the price of certain goods. Also, the rising cost of living has put pressure on employers to increase the wages of their staff to help ease the financial pain they are experiencing. Much like the increases in energy prices, some, if not all, of these wage rises are also getting passed on to consumers, which increases the cost of living further.

These are all key factors in why European countries are now facing high levels of inflation; the rate at which prices increase over a given period of time. Whilst some inflation in an economy is generally seen as positive, high inflation is not as it reduces people’s purchasing power. This means they must spend more to buy their usual “basket of goods”, which can impact other parts of the economy.

When high inflation occurs, Governments (or to be more precise central banks) use the main weapon they have in the fight against inflation – raising interest rates – as the European Central Bank, the Bank of England and the US Federal Reserve have recently done. The aim of doing this is to encourage people to save money, rather than spend it, and make borrowing more expensive, all of which encourages people to buy fewer things and should slow price rises and reduce inflation. However, the downside for those with debt, including mortgages, is that they are likely to see their monthly repayments go up, which can make the cost of living crisis worse.
 
So what can you do to lessen the impact of the rising cost of living? The obvious ways are to reduce the amount of energy you use each month and change the way you shop, both of which can help cut your monthly spending. Fortunately, you can find great energy-saving tips in our article Saving energy and money this winter and shopping tips in our articles How to save money on food and Making the most of discounts which will help you on your way. It is also the perfect time to start developing good money habits if you haven’t already done so. Our article Creating good money habits will help and includes advice on budgeting, saving, and checking your bank account as often as you do your social media!

Fortunately, financial crises such as this do pass. We hope that understanding why it is happening, how it might impact you and what you can do to get through it helps.