Inflation Flashcards
What’s inflation?
A persistent increase of prices in an economy in a year
How is the CPI conducted?
- Expenditure survey carried out among 10,000 households.
- A ‘consumer basket’ of the 650 most popular goods/services is formed with average prices attached
- 100,000 items are checked in over 100 outlets.
- Prices of these goods/services are weighted based in % of income
- Weighted prices are added to give total weight of the basket
What are the evaluations of the CPI?
Personal inflation rates may differ to the ‘average family’
Price fluctuations of certain goods
They don’t include housing costs
Basket updates may be too slow
What’s demand pull inflation?
When aggregate demand shifts to the right.
How are the components of aggregate demand affected by demand pull inflation?
Lower interest rates
Lower income/corporation tax
Higher consumer/business confidence
Higher government spending
Weak exchange rates
What’s cost push inflation?
When SRAS shifts to the left
How does cost push inflation affect the economy?
Higher raw material prices
Higher wages
Higher business taxes
Weaker exchange rates
What are the benefits of inflation?
Workers with higher wages
Consumption is natural
Firms encouraged to increase output
Can keep unemployment low
Reduces the real value of debt
Improvement of government finances
What are the costs of inflation?
Lower purchasing power
Erosion of savings
Lower export competitiveness
Wage / consumer price spirals
Fiscal drag (increased wages makes people pay more tax)
Inflationary noise
What’s the evaluation of inflation?
Depends on the rate of inflation
Depends on the cause of inflation
Depends on the duration of inflation
Is the inflation anticipated?
Depends on the stability of the rate
What’s deflation?
The persistent fall of prices in an economy in a year
What’s malign deflation?
Demand side deflation that shifts aggregate demand to the left.
What’s benign deflation?
Supply side deflation where SRAS shifts to the right.
Why is anticipated deflation dangerous?
Delayed spending - creating the negative wealth effect (fall in mortgage equity withdrawal).
Positive real interest rates
Increases the real value of debt
Wages will fall with prolonged deflation
Why is unanticipated deflation benificial?
Falling prices for consumers
Falling input prices for firms
