3 Inflation Flashcards
Define inflation
The rate of change of the average price level: for example, the percentage annual rate of the CPI .
Macro economic policy of low and stable inflation means
Inflation levels below 2%
Define deflation
A situation in which the average level of prices is falling - this is negative inflation
Disinflation
Reduction in the rate of inflation
Hyper inflation
Monetary inflation occurring at a very high rate
Measures of inflation CPI
Consumer price index : a measure of the general level of prices in the U.K., adopted as the governments inflation target since Dec 2003
Index based on a bundle of g/s.
180000 individual price quotes on 680 different products collect by ONS each month.
Data spending on ‘household final monetary consumption expenditure’ is used to allocate weights to items in the index.
Weight updates each year
CPIH Addresses alongside CPI a value including housing costs of owner occupiers. Launched march 2013
Alternate measure of inflation RPI
A measure of the average level of prices in the uk
Retail price index
Average of the basket good costs
Shows how the general level of the prices has changed relative to the base year
Calculate the rate of inflation using index numbers
Choose a year for base prices
Calculate cpi/rpi
Percentage change is the rate of inflation
Advantages of using an index
RPIX felt to be a better measure of the effectiveness of macro econ policy as it includes mortgage interest payments
CPI is a more appropriate indicator for evaluating policy effectiveness and can be used for international comparisons of inflation
Changing the weights on an annual bases aims to limit the impact of major consumer behaviour changes
When calculating weights cpi uses pensioner households and highest income households - rpi does not
Disadvantages of index such as cpi and rpi
CPI (used for low and stable inflation)
- basket may not be representative of al consumers - inflation rate will not be not specific to every individual in the economy
- inaccuracy in data/ error in data collection
- other countries may have different means of measurement allowing for difficult comparison
CPI excludes house of costs ( mortgage interest repayments/rent/council tax)
CPI is geometric and RPI is arithmetic - therefor RPI tends to give higher rates of inflation.
- the basket may not change frequently enough to accurately exemplify consumer behaviour. This risks distorting the true impact of inflation. Difficulty is presented in addressing the substitution effect
- when basket products shift often comparisons to the past are problematic
- inflation isn’t the only indicator of economic performance (PPI may be used for a forward looking guide)
Evaluate the causes of inflation (demand pull) draw diagram
In album
Inflation initiated by an increase in aggregate demand
Increase in ad causes increased pressure on prices
Why
Closer to yfe= raised pressure on existing CELL because the economy is exhausting more and more spare capacity
- this higher pressure on CELL Brings a higher price because FOP are scarcer
Reasons : any increase in AD
Causes of cost push inflation + diagram
Album
Experience by supply side of the economy
Increase in price of raw materials / cost of production
- this impacts supply side shocks from short run AS
- rise in price of oil (big factor)
- sudden increase in wages (cop rises)
- when imports are more expensive
This is deemed most severe as there is a reduction in growth ( demand pull at least has increase in growth )
Evaluate the consequences of inflation
List the costs (7)
- Purchase power reduction
- menu costs
- shoe leather costs
- fiscal drag
- international competitiveness falls
- anticipated inflation
- savers impact
Cost of inflation
- fall in purchase power of consumers (holds back future consumption)
- menu costs ( reprinting changed prices on menus/catalogs) COP rises + opp cost
- shoe leather costs (opp cost with the time spent finding best options)
- fiscal drag (when tax bands are not adjusted for inflation causing taxes to be inappropriately high when wages are fitted for inflation) prevents confidence and consumption
- reduced international competitiveness - damaged trading position as exports are less competitive whilst imports are more competitive. Increased foreign consumption causes less less export revenue.
- anticipated inflation - inflation spiral (workers demand higher wages which rises COP further exaggerating inflation CYCLE). Consumption led spiral : consume now to maximise current purchase power = scarce resources and rising prices = more inflation.
Inflation benefits
- INFLATION THAT IS LOW AND STBLE
- workers can bargain for higher wages
- incentivises production: prices can increase increase profitability.
- stable levels of consumption. Incentivises consumption - to buy now = healthy consumption habits allows for sustaining increases in growth and production. No erratic consumption changed in the econ
