2.1.2 Inflation Flashcards
What is inflation
a sustained increase in general price level
Does inflation lead to an increase or decrease in PPP
decrease
What is inflation measured in
annual percentage change in consumer price index
What is the target set by the government for inflation using CPI
2%
How does the bank of England control inflation
monetary policy base interest rates
What is deflation
a fall in general price level ‘negative inflation’
What is disinflation
a slowdown in the rate of increase of price
Which countries had the highest rates of inflation in 2018
Venezuela
South Sudan
Sudan
What is Consumer price index
- A base price is selected
- Family expenditure survey is carried out
- representative basket of 600 goods/services is used, and each good is weighted based on importance
- Weights are then multiplied by price changes and weighted price changes are totalled to calculate inflation rate
5 Limitations of CPI as a measure of inflation
- CPI is not fully representative, e.g. for a non typical household
- Spending patterns
- Changing in quality of good/services
- New products, its slow to react to new products + services
- Doesn’t account for regional difference in cost of living
What is hyperinflation
a period of high rates of inflation, usually leading to a loss of confidence in an economy currency
Unit labour cost
Reflect total labour costs, including social security + employers’ pension contributions
Domestic causes for inflation
inflationary pressures within domestic economy
i.e. rising wage cost and increased costs of components parts of raw material
External causes for inflation
These are inflationary pressures outside of a particular country
i.e. increase in global prices/cost of energy
Or movements in a countries exchange rates
i.e. if a currency weakens that will mean imported goods will be more expensive, pushing up domestic production costs
Why are inflation expectations important
Once inflation is established it is hard to remove
Most agents will raise their inflation expectations and build it in to their calculations and decisions
A rise in inflation can lead to a rise in inflation expectations, which can feed through higher wage claims and rising costs
Cost-Push inflation
- Rising costs in the labour market and increasing costs from domestic and oversea suppliers (which is offset onto consumers)
- or supply decreases usually output of Rising import prices due to a falling exchange rate
- goods/services and employment tend to fall because a rise in cost often leads to a fall in business profits and planned investment spending
- Causing inelastic demand
Demand pull inflation
occurs when total demand for goods/services exceeds total supply
As economy approaches full employment (or capacity) labour and raw materials shortages occur more frequently, meaning firms cant expand production
When demand rises, it encourages the produces to raise their prices to increase profit margin
Growth of money supply
when money supply increase quicker than economy’s growth rate can lead to inflation
Fisher Formula
MV=PT M=money supply V= velocity of money i.e. how long it takes to move through market P=price level T=volume of output
4 Winners from rising inflation
- Workers with strong wage bargaining power, like trade unions
- debtors, if real interest rates on loads are negative
- Producers if their prices rise faster than costs
- Wealthy groups if their is a sustained period of asset price rise
5 Losers from inflation
- retired people on fixed incomes, inflation erodes real value of savings
- lenders if real interest rates on loans are negative
- Savers
- Workers in low paid jobs
- Exporting firms
4 Risks of high and volatile inflation
- Inequalities
- Falling in real income/wage inflation
- Negative real interest rates/decrease in borrowing
- Business uncertainty
Causes of deflation
- Demand-side causes deflation, deep fall total demand and high spare capacity
- Supply-side, total, supply in economy rises more than demand
3 Countries with lowest inflation in 2018
St. Kitts and Nevis
Ecuador
Djibouti
5 Economic effects of deflation
- Holding back on spending (confidence), meaning lower profit margins for businesses
- Debt/interest/borrowing increases
- Income distribution
- Deflation makes exporters more competitive
