INFLATION Flashcards
What is inflation ?
The sustained increase in the price level of goods and services leading to a fall in the purchasing power of money
What are some limitations of the CPI ?
Spending habits alter between households
Price may change due to a change in the quality of a good
CPI is slow to respond to new products
Average annual figure is never the actual figure experienced
What are the main causes of inflation ?
Demand pull factors
Cost push factors
Administered prices
Factors that affect demand pull inflation ?
Lowered I rates increase consumption
Decreased taxes increases disposable income
Increases in GOVT spending
Factors that affect cost push inflation ?
Increased price of raw materials
Increase in wages
Increased business taxes
Weaker exchange rate
Name some internal causes of inflation
Large surges in property prices
Higher wage / labour costs
Increases in taxes / credit
Name some external factors affecting inflation
Changes in the price of oil and gas
Depreciation of exchange rates
Changes in the price of commodities
Inflation in other countries
What is demand pull inflation ?
When AD grows at an unsustainable rate
Producers can raise their prices to receive larger profits
What is cost push inflation ?
Occurs when firms respond to rising costs by increasing their prices to protect Profit margins
Why is high inflation an economic problem ?
Causes inequality in low income homes
Negative real interest rates ( interest on savings is lower than inflation )
Causes higher cost on loans
Risk of wage inflation ( higher costs and lower profits )
Reduces business competitivness
Who are the winners during a time of inflation ?
Workers with higher wage bargaining power
Producers if prices rise faster than inflation
Who are some loser during a time of inflation ?
Retired people on fixed incomes
Lenders if real interest rates are -
Savers if real returns are -
Workers in low paying jobs
How can macroeconomic policies affect Inflation
Fiscal policy - Less spending on merit goods / welfare / raising taxes
Monetary policy -Higher I rates / less lending / could cause exchange rate to increase
Supply side - To increase productivity , competition and innovation
What is quantitative easing ?
When the BoE Buys assets usually Govt Bonds with money that the bank has created electronically
What is deflation ?
A persistent fall in the GPL of goods and services . The rate of inflation becomes negative
What is Disinflation ?
A fall in the rate of inflation
Still inflation but smaller than last month
What are some demand side causes of deflation ?
Deep fall in AD causing persistent recession
Large negative output gaps
What are some supply side causes of deflation ?
Improvement in productivity
Technology advances
Fall in wage rates
High exchange rates causes imports to fall
What are some consequences of price Deflation ?
People postpone spending if they expect price fall in the future
real value of debts increase - reduces consumer confidence
Real cost of borrowing increases
Falling asset prices reduces confidence and increases saving
What are some macro economic policies to avoid price deflation
Lower I rates and QE - cheaper loans for businesses and expanding credit supply
Fiscal measures - Higher GOVT spending / rise in GOVT borrowing / lower taxes to increase spending
Other - attempts to lower value of exchange rate , higher taxes on saving to encourage spending
What are the costs of high inflation ?
Lower purchasing power - workers are less off - affects ability to buy necessities
Erosion of savings , savings lose value - affects those who rely of savings like unemployed , OAP’s and economically inactive
Risk of wage price spiral - causes a rise in costs of production - firms pass on more costs to customers ( cost push inflation )
Fiscal drag - inflation rising and workers are receiving higher income in line with inflation could drag them into higher tax bands meaning they are less off
What are the benefits of low and stable inflation ?
Workers can bargain for larger wages / improves morale and productivity
Firms encouraged to increase output as they know they can raise their prices and earn more revenues
Reduces the real value of debt - becomes easier to pay off debts if wages rise in line with inflation
Improved state of GOVT finances = fiscal windfall - any nominal values of tax as prices rise they will receive more VAT taxes as prices rise
What are some methods to reduce demand pull inflation ?
Contractionary monetary policy - Increased I rates to reduce AD
Contractionary fiscal policy - A cut in GOVT spending or increased taxes
What is the effect of contractionary monetary and fiscal policy ?
( DEMAND PULL INFLATION )
We could see :
Less economic growth
Higher unemployment
Causes recession / less macroeconomic objectives
Higher I rates reduces investment / lower competitiveness
Impacts those who have debts / reducing living standards
