4.8 inflation and deflation Flashcards
Def of inflation
Overall increase in price levels related to declining value of a currency
Def of deflation
Overall decrease in price levels related to increase value of a currency
What are the 2 causes of inflation
Demand pull
Cost push
What is demand pull inflation
rises in the price level caused by excess demand
What is cost push inflation
rises in the price level caused by higher costs of production
What are the consequences of inflation
Lower purchasing power
Exports are less internationally competitive
Inflation causing inflation
Fixed income groups, lenders, and savers lose
Why is there lower purchasing power in periods of inflation
the higher the price levels rise, the lesser number of goods and services you can buy with the same amount of money
Explain why Exports are less internationally competitive
lower priced foreign goods will rival it
How does inflation cause inflation
cost of living in the economy rises
workers to demand higher wages
Cost of production increases
Price levels increase
Cycle
Why do fixed income groups lose
Why do lenders lose?
Why would savers lose (if any loss)
Purchasing power of money falls. Fixed income group people can’t ask for an increase.
Lenders only get the same amount of money they lent before inflation, but the purchasing power has gone down and hence the value has gone down.
Savers also lose because the interest they’re earning on savings in banks does not increase as much as the inflation, and savers will lose the value on their money.
What policies are employed to reduce inflation
Contractionary monetary policy
Contractionary fiscal policy
Supply side policies
How does contractionary monetary policy reduce inflation
Draw backs
Increasing interest rates
Saving is encouraged
Spending and investing is reduced (more expensive to borrow)
Reduces the money supply in the economy
Spending and investing may still continue to rise as confidence remains high. There is also a considerable time lag for monetary policy to take effect.
How does contractionary fiscal policy reduce inflation
when is this employed
Increasing tax - reduces disposable income. Spending will reduce. cutting down on government spending will reduce aggregate demand
when inflation is severe
How do supply side policies reduce inflation
drawback
Aim to make firms competitive and efficient, and thus avoid inflationary pressures. Eg deregulation and privitisation
Long run only. Cannot correct short term inflationary pressure.
How do supply side policies reduce inflation
drawback
Aim to make firms competitive and efficient, and thus avoid inflationary pressures. Eg deregulation and privatization
Long run only. Cannot correct short term inflationary pressure.
How do supply side policies reduce inflation
drawback
Aim to make firms competitive and efficient, and thus avoid inflationary pressures. Eg deregulation and privatization
Long run only. Cannot correct short term inflationary pressure.
What are the causes of deflation
Aggregate supply exceeding aggregate demand
Labour productivity has risen:
Technological advance
What happens when Aggregate supply exceeding aggregate demand
excess of output in the economy not consumed, causing prices to fall.
Why is there deflation if there is increased productivity and technological advance
Higher output
Lower average costs
reduced cost of production
Leads to deflation
What are the consequences of deflation
unemployment - production may get discouraged
Investors are discouraged to invest because of falling demand/prices
Can cause recession - firms are forced to close down as enough profits are not being made.
Tax revenues of govts fall
Borrowers are at a loss since value of the debt they owe is higher than when they borrowed the money.
What are the policies to control deflation
Expansionary monetary policy
Expansion fiscal policy
Devaluation
Change inflation expectations
How would expansionary monetary and fiscal policy control deflation
draw backs
Monetary - Increased spending, low saving
drawback - liquidity trap
Fiscal - cutting direct taxes and increasing govt spending. Money can be raised through quantitative easing.
What is a liquidity trap
what does it render ineffective
Contradictory economic situation where interest rates are low but savings are still high. Renders expansionary monetary policy ineffective.
How does devaluation control deflation
export prices to fall, encouraging production of exports, resulting in higher demand;
Increase prices of imported products which will raise costs and prices for products in the economy.
How would changing inflation expectations control deflation
People expecting deflation causes deflation. businesses won’t increase wages and consumers won’t pay higher prices (because they expect prices to fall in the future).
But if govt changes these expectations to inflation in the future then deflation can be avoided
What is the Wage-price spiral
wage rises leading to higher prices, in turn, lead to further wage claims and price rises
