Inflation
Inflation is a sustained rise in an
economy’s general price level.
This means that, on average, the
prices of goods and services are
going up over time.
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Inflation - Disinflation - Deflation
Reflation: the rise in GDP which occurs following a recession
Stagflation: a period when inflation is rising, or very high, at a time when
the economy is in recession
- Deflationary policies: designed to reduce the rate of economic growth ———
to reduce inflation rate (normally not linked to deflation)
Measuring Inflation
Consumer Price
Index
Retail Price Index
It is measured by an Index. If today’s price index were 100, and 110 in a year’s
time, the inflation
rate would be 10%
A Consumer Price Index (CPI) is a measure that tracks changes in the
average price level of a basket of goods and services purchased by a
typical household over time.
It is a widely used economic indicator for assessing inflation and cost
of living adjustments.
CPI is calculated by comparing the current prices of the items in the
basket to the prices of the same items in a base year or period.
The percentage change in this comparison reflects the inflation or
deflation rate.
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WHAT ARE WEIGHTS USED IN A
PRICE INDEX?
The consumer price index is a weighted price index
These weights are based on the spending patterns
of households on a wide range of goods and services
In the UK, housing and household services account for 30%
of the inflation calculation
Food and non-alcoholic drink is now less than 10% of the
index
The weights are altered periodically to take account of
changing spending patterns
CALCULATING INFLATION USING A
PRICE INDEX
Selection of the Basket of Goods and Services
Determination of the weights based on spending patterns
Price data collection including retail and online prices
Calculation of a price index using weights
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The accuracy of price indices
Different households
Weights change
CPI: average rate of inflation for all
households across UK
Spending patterns change over time
The causes of inflation
Demand-pull inflation
If TOTAL DEMAND (Aggregate) rises and
there is no increase in TOTAL SUPPLY
(Aggregate) ——— Excess demand in the
economy. Excess demand in the economy =
demand-pull inflation. Average price level
will rise
Possible reasons for demand-pull inflation
- Consumer spending may rise excessively. Low interests rates
—- high consumer spending —- high consumer confidence
during the to house prices rising
- Firms may increase their spending in investment——respond
to large increase in demand from consumers
- Government —- might increase its spending or cutting taxes
Increase in exports (World Boom)
- Possible growth of the money supply (if increasing lending
money—-money supply will grow) Ex: Germany —-
hyperinflation
Cost-push inflation
Changes in the supply of the economy.
Increase cost of production
Possible reasons for cost-push inflation
- Wages and salaries going up
- Rise in price of imports —— Ex: oil, copper….
Due to a Boom, commodity prices to increase.
This will also push the price of finished goods.
- Firms raise prices to improve their profits (PED)
- Government can raise indirect taxes or reduce
subsidies —— increases prices
The cost of high inflation
- Growth and unemployment: unpredictable. Unanticipated inflation. From firms to reduce
investment or consumer reduce their purchases——difficult for firms to supply goods.
- Competitiveness: high inflation —- balance of payment effect. If inflation rises faster than in
other countries, and currency does not change in other currencies, UK exports will be less
competitive and imports more competitive —- loss of jobs in the domestic economy and
lower growth.
- Redistribution costs: redistribute income and wealth between households. Fixed income
(pensions from private sector) will suffer. If real interests rates are negative due to inflation
—- transfer from lenders to borrowers. Taxes from Government should be in line with
inflation.
- Psychological and political costs: it affects the social order
- Shoe-leather cost: less cash, more in deposits with higher interests. Cost to transfer money
to accounts to maximise the interests paid.
- Menu costs: restaurants, shops: Anticipated inflation and indexation
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The cost of deflation
- Lower consumer confidence (Japan ex.
1995 - 2014)
- Lower investment
- Demand to be depressed
- Assets values. If prices fall by 2% and
interests on deposits is 1%, the real return
on savings is 3%—— it encourages to save
more than spend——low or negative rates
of economic growth.
The benefits of low
inflation
- Target around 2% (no problems of high
inflations or deflation)
- Effect on assets prices: not high incentive
to save and it is possible for borrowers to
repay their borrowings.
- Target around 2% (no problems of high
inflations or deflation)
- Effect on assets prices: not high incentive
to save and it is possible for borrowers to
repay their borrowings.
