definition
inflation
A sustained rise in the general price level
common measures of inflation
CPI or RPI
Consumer price indext or retail price index
meaures the changes in prices of a weighted basket of goods bought by consumers over a given period of time
common measures of inflation
PPI
producer price index
a weighted basket of final goods & services and intermediate goods in the production process. e.g. raw materials
Leading indicator for changes in CPI *if producer prices increase is likely to be pased down to consumers
common measures of inflation
GDP deflator
used to convert GDP nominal figures to real figures.
Also includes goods and services produced by governments.
CALCULATION
(Nominal GDP/Real GDP) X 100
terminology
inflation rate
the percentage change in prices from one period to another
terminology
defelation
a persistent fall in the general price level
terminology
Disinflation
a general rise in price levels BUT at a lower rate of inflation
terminology
core or underlying inflation
a measure of inflation excludes volatile prices in the basket e.g excludes prices of oil/energy prices that might br manipulated
terminology
hyperinflation
inflation that is out of control!
creeping inflation
inflation that is presistently at 2 or 3% e.g inflation in EU in late 90’s
uncertainty and growth
consequences of inflation
- uncertainty aboutt future prices
- discourages long-term investment
- growth is likely to be lowered
Redistributes income
consequences of inflation
- borrowers benefit
- lenders lose
- people on fixed incomes lose
- people on profit incomes - raise their prices in line w/ inflation
- importers benefit
- exporters lose - worsenig the BoP
resource costs
consequences of inflation
changing prices means new menues, price lists, price lable
Fiscal drag
may push ppls incomes into a higher tax bracket in a progressive tax system
erodes functions of money + price mechanism
consequences of inflation
- commodity of exchange
- means of deferred payment
- store of wealth
- unit of account
- price mechanism - distorts resource allocation
consequences of deflation
- falling GDP & rising unemployment - can get stuck in deflationary trap
- falling prices & expectations of lower future prices = delayed consumption at present = AD falls = prices fall even lower
- business profits will fall - have to accept new price, unlikely to reduce costs
- real debt values will increase
- indebtedness discourages firms from making new investments
- monetary policy (expansionary) becomes ineffective as a tool.
- exports might becaome more competitive
cost pull inflation
Demand pull inflation
- caused by an increase in AD causing a rise in APL
- C & I might incrrease due to an optimistic and confident households or firms
- X might rise rapidly due to faster income growth in other countries
- G is often the cause of demand pull inflation - irresponsible overspending by governments or generous tax cuts.
cost push inflation
- caused by a rising cost of production (stagflation)
- prices are rising and output is falling - unemployment is also rising
- illustrated by SRAS shift to the left
- caused by oil shocks, falling exchange rate, increase in indirect taxes
combined DD pull and Cost push
results in a **wage price spiral **
- e.g. unions ask for higher wages, causing SRAS to move to the left - then AD is increased causing even higher prices = demand for further wage increases
- an increase in AD to combat slowing growth - causes APL to rise
- overall results in SRAS to shift left
Solutions to Demand pull inflation
contractionary monetary or fiscal policy
- gov. would decrease its spending or raise taxes
- will decrease G + consumer consumption by decreasing disposible income
- raising interests - discourage I and C
- might encourage savings
- idea is to slow AD increases
solution to cost push inflation
- supply side policies - aim to reduce costs of production & move SRAS to the right, lowers APL and higher level of real output
