3. Inflation and Deflation Flashcards
Inflation
the sustained rise in the general price level over time. This means that the cost of living increases and the purchasing power of money decreases.
Deflation
is the opposite of inflation, where the average price level in the economy falls. There is a negative inflation rate
Disinflation
is the falling rate of inflation. This is where the average price level is still rising, but to a lower extent. This means goods and services, are relatively cheaper now than a year ago, and the purchasing power of money has increased.
Hyper-inflation
a phrase of extremely rapid inflation nearly always the result of mass money printing by the government with money as an asset ending up as worthless. It is also associated with economics where there has been a collapse in real output/supply.
Inflation expectations
explains what people and businesses expect to happen to consumer prices in the future. Once a high rate of inflation becomes established it can be difficult to remove. If high prices expected leads to higher wage claims and rising costs, known as wage price spiral.
Stagflation
an unfortunate and costly combination of stagnant ( slow) economic growth, rising unemployment and high and rising inflation.
Calculating inflation using CPI
consumer price index tracks changes in the average price level of a bsket of goods and compares this over a period of time. It tells us the inflation or deflation. A weighted price index is based on the spending patterns of households.
Limitations of the UK consumer price index?
- not fully representative of all consumers
- errors/inaccuracies in survery/samples
- changing quality in G&S
- CPI is slow to respond to new products in markets.
Challenges in measuring inflation
- consumer preferences change over time
- consumers tend to adjust their spending patterns in response to price changes
- the CPI must make quality adjustments to account for quality
- CPI is national, doesn’t consider regional
- Differences with other demographics
Main causes of inflation
money & credit boom, higher wage costs, increased energy bills, falling exchange rate, high indirect tax, economic boom.
Cost push inflation
occurs when businesses respond to rising variable costs and increase prices to maximise profits.
Causes: rising labour costs, increase in costs, depreciation of currency, indirect taxes.
Demand pull inflation
a phase of accelerating inflation which arrises from a rapid growht in AD. Occurs when economic growth is too far.
Businesses want to take advantage of high demand.
Causes: AD> Supply. Price rising become consumers willing to pay more.
Monetarism
- empahsises the role of money supply in determining price levels and inflation
- rapid increase in money supply can lead to inflation
- monetarists critisise fiscal policy for being impredictability and causing instability.
-belief in long-run neutrality of money - as money grows people have more to spend hence the prices go up.
Causes of the surge in UK inflation in 2022-23
- as the world economy recovered, there wasn’t much supply of raw material. Demand pull inflation.
- conflict in Ukraines has caused a spike in energy prices.
- there have been labour shortages in healthcare and logisitics.
What is greed inflation
- AKA price goughing
- price gouging involves charging excessive prices in increased demand or limited supply.
- scarcity and higher demand lead to higher prices in such situations.
- sellers exploit the situation by charging unreasonable prices comparing to normal market conditions.
What is shrinkflation
involves reducing the size of a product whilst keeping the price the same.
they are able to do this without customers noticing.
Consequences of high inflation rate
it erodes value of money, which doesn’t go as far as it used to, uncertainty and instability for businesses.
Relative inflation rate matters because it can lead to imbalances in trade.
Capital flight
selling your assets in a country with a bad economy and buying in other countries.
Economic costs of high inflation
inequality, falling real income, negative real interest rates.
Wage price spiral definition
is a situation where workers bid for higher wages because they have seen their real incomes eroded by fast-rising prices.
This can lead to a further burst of cost push inflation in an economy.
Spiral of wage price steps
Cost of living increase -> real incomes fall -> workers try negotiate better pay -> unit labour costs for firms increase -> businesses increase prices -> GPL increases.
Policies to help control inflation
Demand pull:
1. increase interest rates - reduces supply of credit.
2. contractionary fiscal policy - higher taxes and cuts in state spending.
Cost push:
1. supply-side policies to increase productivity
2. labour market reforms to increase labour supply.
- expansion of the worker-visa program
- increase house building
- investment in human capital
- investment tax allowance
- infrastructure investment to help lower business costs.
Reasons why inflation is hard to control
- fluctuations in global commodity prices, exchange rates.
- supply side shocks
- built in inflation expectation
- monetary policy lag
Asset price deflation
when valuation of assets such as bonds, housing, and equities fall over a sustained period. Happens at end of financial bublles.
Economic impact of a period of deflation
- real interest rates rise
- real level of debt rise
- rise in cyclical unemployment
- pressure for lower wage
- declining business profits
- improved price competitiveness
Consequences of price deflation
- consumers will hold back demand when expecting prices to fall
- real value of debt rises
- lower profit margins
- falling asset prices
