3.3 inflation and deflation Flashcards
what is inflation
a rise in the general price level which leads to the devaluation of money
what is deflation
a fall in the general price level- average prices are falling
what is disinflation
a decline in the rate of inflation, prices are still rising but at a slower rate, eg 5%-3%
how is inflation measured
changes in the consumer price index (CPI) who h measures the changes in the prices of a selection f household goods
what does inflation look like I a healthy economy
low and stable
what is the governments target for inflation
2%
what are high rates o inflation damaging
creates uncertainty and undermines the price system,
money looses value quickly
lower growth and unemployment
what is cost-push inflation
a rise in the costs of production that causes the SRAS curve to shift to the left, pushing up the prices to maintain profits
what are the causes of cost-push inflation
increase in the national minimum wage trade unions increasing minimum wage increase in the price of raw material external supply shocks rise in indirect taxation rise in cooperation tax falling productivity exchange rate depreciation, increasing the cost of imports
what is demand-pull inflation
increased AD which the AS can’t keep up with so the prices are pulled up
what are the causes of demand pull inflation
excessively ‘loose’ fiscal policy- income tax cut too much
excessively ‘loose’ monetary policy- interest rates cut too much
exchange rate depreciation-our exports cheaper
rising confidence- positive wealth effect from rising asset prices- houses
excessive borrowing
global economy experiencing faster growth in incomes and increasing their demand for uk goods + services causing AD to rise
what are the consequences of high inflation on consumers
erodes the real value of money and real incomes fall
reducing living standards
inequality rises as skilled workers have more power to negotiate nominal wage increases
shoe leather costs - customers shopping around to find good prices
savers lose out as real interest rates fall
borrowers gain due to the fall in real interest rates
those in debt gain as they debt loses value
consequences of high inflation on businesses
uncertain due to volatile prices leads to less investment
falling international competitiveness as exports are more expensive
menu costs- eg changing price lists and accounting procedure updates
what are the role of expectations on inflation
if people expect inflation to rise they may send more now to avoid the future higher prices, this leads to a rise in AD which could push the price up even more
what is a wage inflationary spiral
as inflation rises, workers ask for higher nominal wage, which increase business costs, which pushes up costs and prices further, so workers ask for a further rise, starting a spiral
what are the consequences of deflation
unexpected deflation raises real interest rates which is bad for borrowers but good for savers
reduces the effectiveness of expansionary monetary policy
lower profit margins means less investment
can improve international competitiveness of exports
falling prices may cause consumers and firms to delay large items of investment - causes AD to fall further - creating a spiral
what is malign deflation
a significant fall in aggregate demand, it is accosted with a severe recession, like the Great Depression in the 1930’s
what is benign deflation
a significant and prolonged fall in the costs of production, usually associated with technological development, eg the industrial revolution
what do monetarists believe inflation is caused by
an increase in the money supply = shown in the quantitive theory of money
what does the quantitive theory of money explain
the links between the money supply and the general price level, it is based on the fisher equation
what is the fisher equation
Money Supply (M) X Velocity of the circulation of money (V) = price level (P) X real GDP (Q)
MV=PQ
what does the fisher equation tell us
if velocity is constant then a percentage rise in the money supply will have an equivalent percentage rise in nominal GDP (price level X GDP)
