3.3 Inflation and Deflation

Question 1

What was inflation and deflation like in the 1960s-1990s

Answer 1

• unnaceptably high rights of inflation

-

Question 2

What was inflation rate like through 1993-2008?

Answer 2

• under control

Question 3

What was inflation like after 2008?

Answer 3

concern was mainly deflation due to recession

Question 4

What is demand pull inflation caused by and what is it?

Answer 4

• caused by excess aggregate demand for goods and services
• demand side of economy
• too much money chasing too few goods and services

Question 5

What are the 6 causes of demand pull inflation?

Answer 5

• lower income tax ( increases disposable income)
• lower interest rate (borrowing is more attractive and saving less rewarding)
• general rise in consumption (higher incomes and consumer confidence)
• improved availability of credit / money supply. (credit boom leading to more borrowing, consumption and investment increases_
• a weak exchange rate (boost exports)
• fast growth in other countries (increase demand for Uk exports)

Question 6

What is monetarism?

Answer 6

economic theory that believes that money supply is the chief determinant of current dollar GDP in the short run and the price level over longer periods

Question 7

What is cost push inflation?

Answer 7

when firms respond to rising costs of production by increasing prices

Question 8

What are the causes of cost push inflation?

Answer 8

• wage increases
• stronger trade union power
• higher raw material costs
• higher taxes
• higher import prices
• natural disastors

Question 9

How do wage increases cause cost push inflation?

Answer 9

• wage is largest single cost of production
• if prices are rising, workers will demand higher wages to protect real wages. if higher wage costs are reflected in higher prices, further pushing up inflation , workers continue to demand higher wages

Question 10

How do stronger trade union power cause cost push inflation?

Answer 10

• growth of monopoly power in labour market, in form of growing trade union strength for inflation

Question 11

What will a rise in world price of commodities feed through to?

Answer 11

Uk inflation as many commodities are price inelastic products

Question 12

What do all imported goods / commodities include?

Answer 12

• raw materials, food, energy, consumer goods such as manufactured goods, capital goods and semi manufactured goods used for production

Question 13

what are emerging markets creating a growing demand for ?

Answer 13

goods and services globally

Question 14

What has the growing demand for good and services globally led to?

Answer 14

demand pull inflation
- during boom, Uk imports inflation from booming economies through imported food and raw materials

• during recession, Uk faces lower inflationary pressure

Question 15

What can peoples expectation of future inflation affect?

Answer 15

current rate of inflation
- if people expect the inflation rate next year will be high, they will behave in an inflationary way to avoid being left behind when expected inflation materialises.

Question 16

What will people do when they suspect high inflation?

Answer 16

• trade unions and workers bargain for higher wages

- firms rise prices

Question 17

What are the consequences of low and stable inflation?

Answer 17

• easy to anticipate next years inflation rate
• associated with growing markets, healthy profits and business confidence
• a necessary side effect or cost of expansionary policies to reduce unemployment
• necessary to make labour markets function fully

Question 18

Who are the winners from high inflation?

Answer 18

• workers with strong wage bargaining power
• debtors if real interest rates are negative
• producers if prices rise faster than costs

Question 19

Who are the losers from high inflation?

Answer 19

• retired on fixed incomes
• lenders if real interest rates are negative
• savers if real returns are negative
• workers in low paid jobs

Question 20

What seven ways could inflation make the economy less efficient and competetive?

Answer 20

• distributional effects
• low or negative real income
• distortion of normal economic behaviour
• breakdowns in the functions of money
• lack in int competitiveness
• shoe leather and menu costs
• business uncertainty

Question 21

Explain effect of distributional effects?

Answer 21

• inflation acts as hidden tax, redistributing income and wealth from lenders to borrowers. people on fixed income loose out

Question 22

Explain the effect of low or negatice real income?

Answer 22

• leads to low level of saving and high level of spending which may cause demand- pull inflation

Question 23

Explain effects of inflation on distortion of normal economic behaviour>

Answer 23

• households bring forward purchases and hoard goods if they ecpect inflation rate to rise

Question 24

Explain effects of infaltion on breakdowns in the functions of money?

Answer 24

• money becomes less useful and effecient as a medium of exchange and store value

Question 25

How does inflation lead to a lack of international competitiveness>

Answer 25

- when inflation is higher then in competitor countires, exports become more expensive, lower AD, lower growth and rising unemployment. exchange rate may fall, causes higher import prices and cost-push inflation

Question 26

Explain effect of inflation on shoe leather and menu costs?

Answer 26

- consumers incur shoe leather costs, spending time and effort shopping around and checking which prices have or have not risen , incur menu costs, having to adjust prices more often

Question 27

Explain effect of inflation on business uncertainty?

Answer 27

high and volatile inflation is not good for confidence partly because businesss cannot be sure of what their costs and prices are likely to be

Question 28

What four policies could be used to reduce inflation?

Answer 28

- monetary policy - fiscal policy supply side policies - direct controls

Question 29

What do policies that reduce inflation aim to do?

Answer 29

either: - slow down growth of AD - boost rate of aggregate supply

Question 30

Explain the monetary policy?

Answer 30

- tighten monetary policy through, higher interest rates, reversal of quantitative easing or tougher controls on bank lending

Question 31

How do the higher interest rates in the monetary policy reduce inflation? -

Answer 31

- higher cost of borrowing ( borrowing falls) - saving is more attractive - reduces disposable income of those with mortgages - higher value of exchange rate leading to lower exports and higher imports

Question 32

Explain the fiscal policy?

Answer 32

- government reduces its own spending or public and merit goods or welfare payments - by raising direct taxes (lower disposable income). could lead to lower output having a negative effect on jobs and economic growth

Question 33

Explain supply side policies?

Answer 33

- increase porductivity, consumption and innovation - reduction in company taxes to increase investment - reduction in taxes which increases risk taking and incentives to work

Question 34

Explain the use of direct controls?q

Answer 34

- public sector pay controls (limiting pay rises for NHS workers) - capping or other regulation of prices of utilities (water bills)

Question 35

What is the most appropriate way to control inflation in the short run?

Answer 35

for the government and central bank to keep control of AD to a level of consistent with out productive capacity

Question 36

What is deflation?

Answer 36

persistant fall in the general price level of goods and services

Question 37

What are the demand side causes of deflation?

Answer 37

- deep fall in AD causing a persistant recession / depression - large negative output gap - falling real output and rising unemployment

Question 38

What are the supply side causes deflation?

Answer 38

- improved productivity - technological advances - significant fall in wage rates - high exchange rate causing import prices to fall - rising real output and employment

Question 39

What are the seven consequences of deflation for individuals and the economy?

Answer 39

- holding back on spending (expecting prices to fall) - debts increase ( lower consumer confidence) - real cost of borrowing increases (interest rates will rise, saving increases) - lower profit margins (reduce revenue for businesses, higher unemployment) - confidence and saving (falling asset prices, lower confidence) - income distribution (redistribution on income) - exporters more competitive

Question 40

What are the three policies to avoid inflation?

Answer 40

- low interest rates and quantitative easing - fiscal stimulus measures - other ways of stimulating demand

Question 41

Explain how low interest rates and quantitative easing will avoid deflation>

Answer 41

- cheaper loans for businesses and households | - expanding supply of credit in banking system

Question 42

Explain the fiscal stiumlus measures in deflation?

Answer 42

- higher government spending - rise in government borrowing to inject demand into circular flow - lower direct taxes to increase disposable income and spending

Question 43

how did lower interest rates fail to solve low inflation?

Answer 43

- people preferred to save becuase on ongoing recession - people took opportunity to pay off debts - banks didnt want to lend, firms couldnt get loans despite low rates - banks didnt pass the full base rate cut onto consumers