Inflation Flashcards
Money
Set of assets/stock in economy ppl use regularly to buy goods/services
Inflation
Increase in overall level of P
Price level
Average level of P & value of money
Inflation
Persistently rising PL
Deflation
Persistently falling PL
Inflation rate
Annual % rate of increase in the average PL
Why is unpredictable inflation/deflation a problem?
Lowers RGDP and employment, redistributes wealth (to well off people)
CPI
Measures the average of prices paid by consumers for “fixed” basket of goods
ONS reports it monthly and it is used to monitor changes in costs of living over time
How do we calculate CPI inflation rate?
Find the cost of the CPI basket at base-period P, then at current-period P
Year n inflation rate = CPI in year (n) - CPI in year (n-1) / CPI in year (n-1) * 100
What might make the CPI bias?
New goods bias
Quality change bias
Commodity substitution bias
Outlet substitution bias
Hyperinflation
Very high + accelerating inflation that quickly erodes the real value of the local currency, e.g. Zimbabwe 1990s
Are there any costs related to inflation?
Menu costs (adjusting price labels + price lists in menus/catalogues)
Redistributive effects (e.g. inflation takes away from pensioners and redistributes it to asset-holders (property), rises in value)
Uncertainty > lack of investment
Effect on BoP
Demand shocks
Events that lead to unforeseen changes in planned AE
Supply shocks
Unanticipated events that lead to firms changing their planned Q levels
Pure inflation
Goods and input prices rise at the same rate
What are the 2 main inputs whose prices can change in the SR?
Materials + fuels
Labour
Interest rate (IR)
Price paid by a borrower of money to lender in return for the funds
What causes hyperinflation?
Large amounts of govt expenditures (e.g. post-war reconstruction)
Financed by central bank printing money (directly lending to govt)
Aggregate supply
Total of all the outputs of goods + services that firms wish to produce and sell over a specific time period, i.e. the economy’s GDP
What does the Phillips curve show?
The level of unemployment to the rate of change of money wage rates (nominal wages)
What happens if expected inflation < actual, vice versa?
Expected < actual = lower costs of hiring labour, firms hire more workers -> u < u* (unemployment rate < natural rate)
Vice versa, u > u*
Disadvantages of the LRPC?
Some economists argue people are ‘backward-looking’ (use data from past to form expectations on future > adaptive expectations)
This means agents can constantly be fooled by policy maker
What does the LRPC show and how is it illustrated?
Sooner or later, the economy will return to U* (natural rate), whatever the inflation rate
Vertical line, inflation on y-axis and unemployment on the x
