Inflation Flashcards
What is inflation?
Inflation is the increase in the general level of prices over a given period of time. It affects consumers purchasing power and deters investment as firm find it difficult to plan for the future.
What is deflation?
Deflation is the opposite of inflation. It occurs when the general price level goes down over. A given period of time. The inflation rate will fall below 0%, this it is called negative inflation.
It will deter investment, lead to high unemployment and low economic growth. People would not be able to pay back their loans, thus leading the economy into a recession. A price spiral may even occur. Firms will be reluctant to invest, thus they may lay-off workers.
What is hyper inflation?
Hyperinflation is one of the 4 degrees of inflation. It is a very high and typically accelerating inflation, at the rate of 50%+ per month. It quickly erodes the real value of the local currency, as the prices of all goods will increase rapidly. This may cause people to minimise their holdings in t that currency as they usually switch to a more stable foreign currency.
Zimbabwe, Venezuela, and Argentina are all countries which are experiencing this type of inflation.
What is the Harmonised Index for Consumer Prices (HICP)?
To study the behaviour of inflation across European countries, the HICP should be used. In fact, in the EuroArea, the HICP is sued to measure consumer price inflation. It captures the change in the level of prices of consumer goods/services purchased by EuroArea households.
Although it is complied by EuroStat and national statistical institutions in accordance with harmonised methods, it is carried out by the NSO.
It is the primary tool used by the ECB to assess price stability. Its weights are updated annually, with 12 subcategories. These include tourist attractions and social protection. It uses a chain-linked index, which is updated each year. Thus it is more realistic for latest spending patterns. It calculates based on spending by private households, institutional households and tourist.
What is demand-pull inflation?
Demand-pull inflation is inflation caused by continuous increases in AD. This is not a one off consumer spending. As AD increases and reaches the inelastic part of the AS curve, the price will increase more-than-proportionate than a change in Y.
The closer AS is to full employment, there is less spare capacity in the economy. This results in firms responding with higher prices.
A shortage for factor inputs at full employment will result in an increase in factor prices. Thus, increasing the firm’s cost of production, will in turn force firms to increase the prices of their products.
When an economy is booming, we will expect high demand-pull inflation.
What is cost-push inflation?
Cost-push inflation occurs independently of AD. It is caused by continuous negative supply shocks, resulting in an increasing in the costs of production.
Real output is decreasing, thus we are entering a recession. If the government tries to increase AD, this will only rise prices higher. Demand-side policies don’t work, so we have to use supply-side policies instead. These include: government spending and tax reform.
What type of inflation will an increase in the price of utility tariffs cause?
An increase in the price of utility tariffs will cause cost-push inflation. Higher costs will increase the cost of production, thus if costs of production increase, firms will pass this burden on consumers through higher prices. Thus will increase prices and reduce output.
What is the Retail Price Index (RPI)?
The Retail Price Index is a measure of inflation used in Malta.
It is used for economic analysis and policy making, such as: to set the COLA, to revise income tax brackets, and to revise excise duties.
The RPI is more reliable to measure the cost of living as it bases spending by private households. It has 10 categories, and its weights have a fixed base index. Thus its weights have not been updated since 2015.
What is the 12-month moving average inflation rate?
The 12-month moving average inflation rate compares the average of the last 12 indices to the average of the previous 12 indices.
For example, it compares the average of Jan-Dec 2020, to the average of Jan-Dec 2021.
It is less sensitive to temporary price changes, and therefore less volatile. It is used to calculate the COLA.
What is the target inflation rate?
The Council adopted a new symmetric 2% inflation target over the medium term and confirmed that HICP remains the most appropriate price measure.
This is done to practice price stability.
Before July 2021, it was less but close to 2%, but due to inflation it has been increased to 2% to allow more flexibility
Why is 0% inflation bad?
This would lead to a greater burden on prices, and may also lead to deflation which is equally as harmful.
0% inflation shows a stagnant economy. Ideally the inflation rate should be 2% according to the ECB. A 2% inflation rate helps to boost AD, as consumers might buy now, knowing prices will increase in the future. Firms will increase output, to match the increase in consumption. This can provide as a safety barrier to guard against delfation.
What are the consequences of inflation?
- Redistribution of Income and Wealth
- people are caught in higher tax brackets
- savers will lose money as high inflation will eat away the real interest rate - Instability - difficult to plan. This disrupts financial intermediation. Borrowers will be unwilling to borrow money, fearing the possibility of a fall int he inflation rate.
- Price Confusion and Money Illusion
- Firms are reluctant to invest and make long-term commitments. This will impact economic growth and employment negatively.
- Menu Costs
- Shock Leather Costs
- Losing competitiveness internationally
- Current Account Deficit (M>X)
