MONEY MATTERS | What's inflation got to do with it? Plenty, and here's why

He said: "There's something very fishy going on. When I was a young bloke I had to pay 17 per cent interest to buy a home and when I borrowed to start a business I had to pay 20 per cent.

"Now that I don't have to borrow any more," Tony continued.

"... and I have money to put in the bank they are paying me 1.8 per cent. Do you think I should start a bank?".

The financial adviser laughed and said: "It's all got to do with inflation".

When you were paying 17 per cent inflation was 15 per cent.

Since then inflation has been falling steadily. It's now about 1.6 per cent per annum and showing little sign of increasing.

The Reserve Bank aims to create a healthy economy with full employment while keeping inflation low.

Unemployment is too high at present at 5.2 per cent and inflation is low, so it is keeping rates low to boost the economy and create jobs.

"But what about the retirees who want interest to live on? Doesn't the RBA consider them?" Tony asked.

Unfortunately not, the adviser said.

It's up to them, and their advisers, to find other ways to generate income.

"OK, when will inflation go back up and push interest rates back up?" Tony asked.

The adviser said that's the million-dollar question.

Most economists have been expecting inflation to rise by now but it has gone missing in action. It could be a while before it reappears.

"Did you know there was no inflation in Britain from 1660 to 1935? Yes, that's right. The price of a dozen eggs or a bushel of wheat in 1935 was the same as it was in 1660, 275 years earlier" the adviser said.

He didn't expect inflation to disappear like that but he pointed out there was very little inflation from the Great Depression of 1930 until after World War 2.

It took 13 years for central bank interest rates to rise above one per cent again and 22 years to get back above two per cent.

The RBA is targeting inflation of two-to-three per cent per annum and economists expect that.

But maybe inflation only exists because central banks increase the amount of money in circulation faster than the population increase plus productivity growth.

The adviser recommended Tony consider other investments to generate cashflow.

He said: "When you buy a bank term deposit you pay about 50 times the income you get from it. When you buy shares in the bank you pay about 15 times the income you receive. That's way better value".

Other shares are similarly priced.

When you buy residential property you pay about 25 times the income it pays. Look for investments that are cheap relative to the income they will pay you.