7.5 Inflation and the Phillips curve Flashcards
What’s the difference between disinflation and deflation?
deflation: prices are falling
disinflation: prices are rising at a slower rate
What is demand pull inflation?
sustained rise in the price level caused by an increase in aggregate demand
What is cost push inflation?
sustained price in the price level causes by a reduction of SRAS
What is fisher’s equation of exchange?
MV = PQ
M = Money Supply V = Velocity of Circulation of Money P = General Price Level Q = Output produced in an economy
What is assumed about fisher’s equation?
V and Q are stable
This means changes to the money supply directly impact price level
What are the consequences of inflation?
Wage-price spirals Shoe leather costs Menu costs International competitiveness Investment Income redistribution Fixed incomes Savings
What are higher wage spirals and how are they a consequence of inflation?
Higher inflation will increase wage demands from workers to maintain real incomes, which may cause yet further inflationary pressure. It may also place additional strain on industrial relations and pay bargaining
What are shoe leather costs and how are they a consequence of inflation?
A lack of certainty over price levels increases the search costs, predominantly time, of making price comparisons in looking for the best deal
What are menu costs and how are they a consequence of inflation?
The costs to a firm of changing pricing information on e.g. labelling, bar codes, advertising
How does inflation impact international competitiveness?
If inflation is higher than our main international competitors, this is likely to damage our ability to export
How does inflation impact investment?
Given that inflation erodes the value of money over time, inflation will similarly erode the value of investments in the future.
How does inflation impact fixed incomes?
For those on fixed incomes e.g. pensioners, inflation represents a fall in real incomes. It is important for these groups that benefits are correctly index-linked
How does inflation impact savings?
The real value of savings is eroded if interest rates on savings are lower than the inflation rate, which reduces the incentive to save, Conversely however, the real value of debt will fall
How does inflation cause high income redistribution?
Overall, high inflation can have a regressive effect on low and/or fixed income families who suffer more proportionately the higher burden of rising energy or food prices
What are the two types of deflation?
Benign (good) deflation
Malevolent/malign (bad) deflation
What is benign deflation?
Caused by increase in AS, which leads to a lower price level and higher GDP - typically caused by falls in commodity prices or technological advances, decreasing costs of production
What is Malevolent/malign (bad) deflation?
Caused by falling AD leads to falling prices and also falling real GDP (cyclical) - causes a downward multiplier effect
What are the consequences of deflation?
Delayed purchases and consumer spending Wages and Unemployment Debts Confidence International Competitiveness Real Interest Rates Entrenchment
How can other economies affect inflation in the UK?
Growth in foreign economies will increase the demand for UK exports - could lead to demand pull inflation
Recessions in trading partners will ease demand pull pressure due to reduced spending
Growth or increased growth will lead to more demand for commodities and other basic production materials, causing cost push inflation
Changes in the exchange rate will also cause cost push inflation as imports rise
What does phillips work suggest?
That changes in unemployment have direct and, to some degree, predictable effects on inflation
How do you summarise the phillips curve in terms of:
Unemployment
Wage rates
Inflation
- When unemployment is low, wages must be high due to workers being a scarce resource
- This gives them more bargaining power
- Therefore inflation will be high
- This was derived from the AD curve
How do you draw the long run phillips curve model?
- Demand side shock and AD shifts right (unemployment falls in the SR)
- Due to falling unemployment, workers will demand higher wages moving SRAS left (Taking the economy back to YFE at a higher PL)
- This with shift the SRPC right taking it back to the original rate of unemployment
- This then sets the position of the LRPC which is at the NRU and NAIRU and is a LR equilibrium point
What is NRU?
Natural rate of unemployment
What is NAIRU?
Non accelerating inflation rate of unemployment
