2.4 Inflation Flashcards
What are the different types of inflation?
Inflation= rise in the average priced level over time, as measured by the weighted basket of goods. (Expressed as a percentage)
Deflation= fall in the price level, where the inflation rate is below zero.
Disinflation= fall in the rate at which the price level is rising. Price level will still be rising but at a lower rate.(fall in the rate of inflation)
Hyperinflation = occurs when inflation is at an extremely high rate.
What is the policy objective of low and stable inflation?
Low and stable inflation provides price stability.
Price stability is when the price doesn’t change/ low enough change to not affect the decisions of firms or households significantly.
With low and stable inflation Business and consumer confidence is promoted because inflationary expectations can be factored in to to their consumption and investments.
Higher/ volatile inflations distort price signals which help firms and consumers to allocate their scarce resources. It also distorts the signals to workers about the purchasing power of their income and could lead to higher wage demands, leading to more cost-push inflation.
Volatile rates of inflation create inflationary noise. This makes it difficult for firms and households to understand the value of money in the future, thus eroding confidence and therefore savings and investments which are crucial for long term performance of the economy.
What is the UK inflation target?
The UK CPI target is 2%
The inflation band is 1-3%
The CPI is now the Bank of England’s official inflation target
The CPI is a symmetric inflation target
A symmetric inflation target equally weights the deviations above and below the target
What are real and nominal valuations?
When inflation is taken into account we call it real values
Nominal values are unadjusted for inflation (current prices)
Real values are adjusted for inflation taking one per iodine as the base year and using that to see the change in prices over a period of t8me.
What is the consumer price index.
A measure of the general level of prices in the UK which was introduced in 2003 as the successor to the retail price index
The CPI ignores housing costs and council tax.
What is the CPIH?
Introduced in 2017. Covers costs associated with owning, maintaining and living in a home but doesn’t cover the mortgage interest payments.
What is the RPI?
It’s no longer the rate of inflation however it is still used by the govt to index the state pension and as a cost escalator for govt transfer payments and wage negotiations.
Explain and calculate the rate of inflation using index numbers
Both the CPI and the RPI are constructed using the family expenditure survey, which measures changes in the prices of a basket of goods bought by the average family. It changes each year to reflect the consumer lifestyle of households.The data are weighted to account for the relative importance of different items of expenditure and are then used to construct a series of index numbers with a base of 100.
An index number is a device used to compare the value of a variable in one period with a base observation. This can alter the value of economic variables such as wages or rail tickets, in line with inflation.
E.g A laptop= £750 in 2016 and £825 in 2017.
Laptop 2016-2017 index= 100 + ( (825-750)/750 x100) = 110
This shows that the laptop prices have risen by 10% between 2016-2017
What are the causes of inflation?
Demand-pull inflation = due to a rise in aggregate demand in excess of aggregate supply. More significant when the colony experiences a rise in aggregate demand at a time of full employment.
Cost-push inflation = rise in the cost of production causes prices to rise on the supply side of the economy.
Deflation = caused by the lack of aggregate demand, resulting in lower output and possibly the deflationary spiral.
What are the consequences of inflation?
Fall in the value of money, reduction in the real value of income and the purchasing power of income
Reduction in the real rate of interest and the return of investments and savings in the future
Uncertainty about costs of production and therefore unwilling to invest
Loss of international competitiveness of exporting firms
Fiscal drag- tax brackets are not adjusted in line with inflation and when people receive a higher income they are dragged into next tax bracket which leads to a fall in disposable income
Shoe leather costs= cost associated with comparing prices
Menu costs = costs associated with regularly amending lists
What are the consequences of deflation?
Deflationary spiral = lower prices result in households and firms delaying purchases in the expectation that prices will fall further in the future leading to firms output being reduced, employment falls etc
Reduces confidence amongst firms and consumers reducing effectiveness of any govt policy measures to increase economy
Bad deflation will change peoples expectations which will be difficult to reverse as there will be defaults on loans etc Bad deflation comes from an increase in aggregate supply caused possibly by an advancement of technology and the productivity of fixed capital stock.
It can increases the burden of debt on households,firms and govt reducing expenditure from them.
International competitiveness can increase with a fall in prices which can help to improve current account position and increase a firms output, helping to reduce unemployment as aggregate demand rises.
