Chapter 7: Inflation, Fiscal policy and monetary policy (1/3) Flashcards
How is inflation measured?
RPI - Retail price index
-> compares the price of a basket of goods against a similar basket in 1987 (base year)
Who sets the UK target for inflation
The Bank of England Monetary Policy Comittee sets interest rates with a view to meeting the inflation target over the next two years
Current target ~ RPIX 2%
RPIX goes +/- 1% BoE has to write a letter
What is RPIX?
RPI excluding mortage interest payments
What are the 4 consequences of inflation
1) Wealth distribution - FIxed income suffers, borrowers real debt decreases, savers real savings decrease
2) BoP - Increase in inflation - Increase costs of UK goods - Weakening of £
3) Uncertainty - More difficult to plan for future - Prevent investment - damages demand
4) Costs of changing prices - As on tin and harder to compare prices
What is hyperinflation?
When inflation becomes excessive
e.g. Zimbabwe
Solution -> currency substitution (eg. US $)
Stop printing bank notes
What are the two main causes of inflation?
-Cost Push
-Demand pull
What is the cost push?
Increase of cost of production- Increase prices (so firms maintain profits)
Decrease supply
Price level vs nation insurance AS shifts inwards, increasing price and decreasing income
Costs of production increases due to wages, oil prices and imported goods
What is her wage spiral?
Firms increase price, prices increase further, wages demand increase
What is demand pull
When AD of goods and services»_space; AS
excessive growth in AD results in inflationary gap
Inflationary gap - excess prices that have no impact on national income
AD moves out
What is the relationship between inflation and unemployment?
Want to keep both low
HOWEVER,
Inverse relationship between them
Any attempt to decrease unemployment below natural rate increases inflation
What is NAIRU?
Non accelarating inflation rate of unemploymeny
What is a phillips curve?
Inf (%) vs Unemployment (%)
Doesnt account for stagflation
What is an expectations augmented phillips curve?
TO DO
What is fiscal policy?
use of gov spending, tax and borrowing
to influence economic activity, AD, output and employment
affects AD and AS
FP is an instrument of demand, what does that mean?
-FP smooths out any volatility in real national output when economy experiences external shock
Keynesian view of FP:
FP works when operating below full capacity national output or when there is need to provide D-S
gov justiefied to use FP to manage AD
Monetarist view on FP:
FP only has short term impact on AD
scepital
FP: decrease income tax?
increase disposable income increase consumer demand
FP: decrease indirect taxes (spending)?
increase real income increase consumer demand
FP: decrease corporate tax?
increase post tax profit increase capital spend
FP: decrease interest tax
increase disposable income increase consumer demand
Name three types of gov spending
transfer payments - welfare etc
current gov spending - state G+S (NHS, edu, defence, wages etc)
capital spending -add to economys capital stock ( important D?S effects in long term
Justification of gov spending
provide public goods and merit goods (at socially efficient level
saftey net (welfare)
Necessary infrastruction - capital spending
manage AD
What are the canons of tacation
CCEE
Certaintym - easy to predict
Convenience - easy to pay
Equity -fair
Economy - cost effective collection
