Inflation Flashcards
What causes inflation
Demand pull inflation- increase in PL caused by increases in AD. Increased demand puts more pressure on FOP, so workers have to produce more to keep up with demand, and ask for higher wages, so COP up for firms. They then pass this in to consumers via higher prices.
Cost push inflation - increases in PL caused by increased COP, as firms pass on these costs.
What is the quantity theory of money
A theory that links growth rates in money supply to inflation. Only Money Supply can influence prices.
What is the quantitative theory of money equation
MV = PQ
M = money supply
V = velocity of circulation
P = average PL
Q = quantity of Goods and Services sold
Why do Keynesians disagree with the quantity theory of money
Velocity of money can decrease significantly in recessions.
There could be increased money supply but liquidity trap means it doesn’t filter through to the whole economy, so no inflation
What role do expectations play in inflation
When consumers expect inflation to occur, it can become a self fulfilling prophecy.
This can create a wage price spiral. Rising prices —> higher wages due to wage bargaining, —> higher prices
What factors influence expectations in terms of inflation
Current inflation rates
Past inflation
Stage of boom/bust in trade cycle
General economic outlook
Confidence in government or central bank
Wage growth
What happened in the real world that disproved quantity theory of money
Following the financial crisis in 2008, QE increased M, but P did not increase. (There was momentary deflation even in 2010/11)
Problems with inflation
Difficult to slow down inflation without recession
Financial crisis could emerge
Redistributive effect - (decreased value of debt)
Deflation definition
A fall in general PL of an economy.
What are the types of deflation causes
Demand side - AD decreases (worse than supply side)
Supply side - Supply side improvements decrease prices (can almost be good if productivity up for example)
Issues with deflation
Discourages C. Firms and consumers will wait to buy goods hoping that prices will decrease further in the future
Increases the value of debt - has a skewed effect on the people that need money the most and who had to borrow
Can cause real wage unemployment, when sticky wages mean firms have to cut costs by firing people when labour becomes too expensive
Deflation can become a norm, exacerbating previous issues
Bad for confidence
How is inflation calculated
Via weighted changes in price indices m, generally over a year
How are weighted given when calculating inflation
Based on importance of items to spending
What are the major measures of inflation
CPI: main measure of UK inflation used to update pensions, wages and benefits
RPI: Retail price index - included mortgage interest payments
