4.2.3.3 - Inflation Flashcards
Define inflation
A continuous increase in the general price level over time. Meaning the purchasing power of money decreases
Define deflation
A continuous fall in the general level of price per time where the inflation rate is negative
What is disinflation
When the rate of inflation is falling but still positive, the average price level rises but much slower than in the years before
What is creeping inflation
A slow and steady rise in pries over a number of years
What is hyper inflation
Large increases in the general price level by 50% or more per month. The store value of money fails to hold
What is demand pull inflation
When inflation occurs due to a shift in AD
- this is because there is an unsustainable rate of AD meaning AD exceeds AS causing a rise in general prices
What is cost push inflation
When inflation is caused by a shift in AS
- when the increased costs of production leads firms to increase their prices in order to maintain a steady output level
What is consumer price index
CPI
- a family expenditure survey carried out to judge average spending habits
- it is regularly updated and is measured representative basket of goods
- it attached weights to each item in the basket based on its importance in people’s spending
What is a limitation of CPI
- household households experience different rates of inflation
- it doesn’t recognise the quality of the gods and services in the basket
- its slow to respond to new products
What is the real price index
- includes mortgage interest repayments And council tax
- tends to be a higher value than CPI
- excludes the top and bottom 4% of earners
- it was discredited as an accurate figure as the mortgage payments distort the figure
What is CPIH
Consumer price index + housing
- adds owner occupier housing costs and council tax to CPI
- it is otherwise calculated in the same way with CPI with the same basket of goods
What are the 3 causes of inflation
- demand pull
- cost push
- growth of the money supply
What are reasons for demand pull inflation occurring
- reduced taxation
- lower interest rates
- high consumer confidence
- increase in incomes
- weak exchange rate
- fast growth in other countries ( increases demands for export)
What are some reasons cost push inflation can occur
- wages increase
- higher raw material costs
- higher taxes
- higher import prices
- external shocks
How does a growth in the money supply occur
- the quantity theory of money states that growth of the money supply leads to inflation
- an increase in prices would therefore solely be sue to an increase in the money supply
What is the quantity theory of money
The fisher equation is used to demonstrate the changes in price level:
MV=PQ
(Money supply)(velocity of circulation) = (average price level)(national income/output/expenditure)
How can he fisher equation be used to isolate the impact of changes on price
P = MV/Q
- because Q and V are constant, only M can influence prices, so if there is more money chasing the same amount of goods, there will be inflation
What are some issues with the quantity theory of money
- changes in the velocity of circulation & national income/output/expenditure can occur- potentially leading to inflation. despite being presented as constant
- demand pull and cost push inflation isn’t included in the equation
- the money supply is difficult to quantify
How you increase the money supply
- print more money via the Bank of England
- reduce deposit holdings of banks allowing them to led more money
- use quantitive easing
What is quantitive easing
an unconventional form of monetary policy:
- QE involves the introduction of new money into the national supply by a central bank
- this new electronic money is used to buy assets (mainly bonds) from financial institutions such as insurance companies, pension funds and commercial banks
What are bonds
Fixed income financial assets that provide the holder with a stream of income on an annual basis, they are commonly used by the government as a way to borrow money
What is the yield of a bond
The interest as a % of the market price
What us the relationship between the market price of a bond and its yield
There is an inverse relationship, as the market price increases, the yield of the bond falls as it is minimises by the larger value
How does QE impact the economy (11 steps)
1) new electronic money is created by the central bank
2) this is used to but assets (eg: bonds)
3) this increases the price of bonds and causes yields to fall
4) financial institutions sold bonds and have more ‘cash’
5) there is now more liquidity in the financial sector
6) greater liquidity may incentivise financial institutions to lend more
7) lower yields mean lower interest rates
8) there is more, and cheaper credit so both I and C rise
9) as bond prices rise there is a positive wealth effect
10) lower interest rates end to depreciating currency so (X-M) rises
11) leading AD to rise
What is the wealth effect
Lower yields lead to higher share and bond prices
What is the leading effect
QE increases the liquidity of banks and increased lending from banks, lifts incomes and spending in the economy
What is the currency effect
Lowers interest rates has the side effect of causing the exchange rate to weaken which helps exports
Which are the stakeholders effected by inflation
- banks
- savers
- companies
- consumers
- borrowers
- labour
- exporters
What are the costs of inflation on th economy
- reduced confidence ad therefore investment and consumption decreases
- real value of savings decrease so there is a disincentive to save
- income is redistributed from savers to borrowers, real value saving falls and so does the real value of debt
- consumers and businesses on fixed incomes lose out so inequality could rise
- harms trade so reduces uk competitiveness
What are the consequences of deflation
- there is a hold back on sending as people may expect prices to fall lower
- the real cost of borrowing increases so debt increases
- lower profit margins
- wealth decreases and hits confidence - firms investments may decrease
How do changes in other economies affect inflation in the UK
- emerging markets creating growing demand causes demand pull inflation due to the increased exports
- increasing productive capacity in emerging markets leads to lower production costs, so prices are lowered
What is benign deflation
When prices are falling due to improvements in productivity which lowers costs
Malign deflation meaning
Caused by persistent low levels of AD so impacts are more severe
What are the benefits of inflation
- Debts can be payed off
- sustainable growth cab occur
What is core/ underlying inflation
- Measure of inflation without volatile values such as energy and food
- gives a better understanding of what true inflation is looking like
