18. Low and stable rate of inflation Flashcards
WHat is price stability
low and stable inflation
Define inflation
INFLATION: a persistent increase in teh avergae price level in agiven economy at a certain price level
Disadvatages of high inflation
- loss of purchasing power: price level rises but wages stay the same
- effect on savings: value decreases - inflation discourages savings - better buy real estate/art
- effect on interest rates: increase in borrowing price
- effect on international competitiveness: exports less, imports more competitve
- uncertainty: hence discouraged from investing
- labour unrest: disputes if workers dont feel their wages keep up with inflation
Define deflation
DEFLATION: a persistent fall in the average price level ina an economy
Explain good-deflation
from improvements in the supply side/increased productivity (increase in LRAS)
GOOD: increase in output, decrease in unemployment
Explain bad deflation
From demand side (fall in AD - fall in output - lower employment - lower productivity)
BAD: decrease in output, increase in unemployment
Define disinflation
DISINFLATION: inflation of a falling rate
Disadvantages of deflation
Costs of deflation > costs of inflation
- unemployment: low AD - lay off workers -> deflationary spiral: prices fall - consumers put off purchases of durable goods - deferred consumption - fall in AD
- effect on investment: businesses make less profit - reduced investment - harm economic growth
- costs to debtors: a loan rises in value as now the money is worth less than when it was taken - difficult to pay back
How is inflation measured?
Consumer price index (CPI): not all prices change the same - consumer good and service basket - how the price of all basket changes measured each month
Each country creates own representative basket - typical goods and services households buy (surveys) - each category is given weight as some products are more important
Also producer price index (PPI) - tracks prices of goods as they leave factories - before distributors/retailers/wholesalers
Issues in inflation measuring
- typical basket applies not to all people - purchasing habits vary (regionally, financially)
- errors in data collection
- changes in consumer habits
- problematic comparison as countries meaure inflation differently
Types of causes of inflation
- demand-pull
- cost-push
- demand and cost push together
- excess monetary growth
Explain demand-pull inflation
Due to increase in D (change in components) - pulls up price level
Explain cost-push inflation
Due to increase in costs of production - fall in SRAS
- wage -push inflation: increase cots of labour
- cost-push pressures: costs of production - commodities
- import-push pressures: increase in costs of imported capital/commodities
Explain demand pulld and cost push inflation together
Inflationary spiral: increase in AD - increase in price level - higher costs - decrease in SRAS - increase in price level - increase in wages - consumers seem that they have more money - higher AD - higher price level
Explain inflation due to excess monetary growth
Monetarists argue that excessive increase in supply of money is the cause of inflation (increases AD)
Ways to reduce demand pull inflation
Policies to reduce inflation depend on the type
Demand-pull: reduce AD - deflationary fiscal policy (increase taxes, lower gov spending) / deflationary monetary policy (raise interest rates, reduce money supply)
However, contractionary policies are problematic: fiscal would not be favoured by voters, time lag, monetary - increases debt
So monetary policy carried out by central banks - main goal: maintaining low and stable rate of inflation - can make politically unpopular decisions => monetary policy more effective in tackling inflation
Ways to reduce cost push inflation
Policies to reduce inflation depend on the type
Cost push: deflationary demand side policies may bring down price level but will also decrease output - supply side better
However, in reality hard to destinguish between demand pull and cost push - use both demand and supply side in mix
Gov unlikely to make unpopular decision - central bank’s responsibility
For monetarists: money supply should increase the same proprotion as output
