Inflation Flashcards
What 3 things does monetary policy concern
Interest rates
Money Supply
Exchange rates
What are interest rates
The cost of borrowing or the reward for borrowing
Give one example of expansionary monetary policy
A decrease in interest rate
Apart from the ratio of spending/saving, what other effect does rising interest rates have on consumers
Decreased confidence
What are the two types of inflation
Cost push
Demand Pull
Draw the diagram for cost push inflation
Draw the diagram for demand pull inflation
Why is demand pull sometimes considered as ‘good inflation’
It is accompanied by GDP growth
Give 4 causes of demand pull inflation
Higher incomes
Lower interest rates
Lower income tax
Increase in government spending
Why is cost push seen as ‘bad inflation’
It is accompanied by a fall in GDP
What are 4 causes of cost push inflation
Increase in wages (min wage)
Rise in production costs
Rise in corporation tax (Budget links to NI for emplyers, possibly being inflationary )
Rise in global commodity prices
What is inflation
Inflation is the increase in the average price level over time
How is inflation calculated
Calculated by the ONS - they look at goods and services bought by the average family in a metaphorical basket of goods
In the CPI measure, how are categories in the basket weighted
Each category is weighted according to the proportion of income spent on each category by the average family
How can we alter the the CPI measure to be more accurate for a specific group of consumers
By varying the weightings of the basket of goods, or by altering the categories all together
What is index linking
Moving anything in line with inflation
Why might we want a CPI measure for for pensioners or students
May use it to move state pension/ student loan in line with inflation
Give 7 costs of inflation (GAUMIDE)
FISCAL DRAG
- Hinders economic growth
- Creates uncertainty
- Decreases international competitiveness
- Less disposable income for consumers
- Erodes the value of savings
- Menu/shoe leather costs
- Allocation process in a free market is less efficient (decrease in allocative efficiency)
What is the effect of inflation creating uncertainty
Erodes business confidence and decreases investment
How does inflation reduce growth (2 ways)
- Reduces the spending power of consumers which reduces AD
- Contractionary monetary policy in response to inflation (rise in interest rates) leads to less AD
Explain the impact of inflation affecting international competitiveness
UK exports are more expensive relative to other countries
How may inflation make the distribution of income more uneven
High income earning private sector workers are more likely to receive above inflation pay rises than the public sector
Apart from public sector workers, which group is likely to see real incomes fall due to inflation
Those on relatively fixed incomes (Pensioners/benefits)
Explain how inflation erodes the value of savings
If interest rate on a savings account keep up with the inflation rate, this can be prevented. However, REAL INTEREST RATES tend to be negative
What is a real interest rate
I/R - inflation rate
What is a menu cost
Metaphor for the time and effort required to update prices
Give an example of a menu cost
Changing packaging on something that says 25p when increasing the price
What is a shoe leather cost
The time and effort required to check that updated prices (due to inflation) are still the best deals (from suppliers and for consumers)
How does inflation lead to a decrease in allocative efficiency
Due to the signalling function of price no longer working as effectively
What is fiscal drag
- Incomes may rise, yet getting placed in a higher tax band means a greater proportion of income is taxed
Explain fiscal drag
- A rise in nominal incomes leads to a greater proportion of that income being taken in tax-because we have a progressive, banded system
- This means net income is reduced because a greater proportion is lost in tax
How may fiscal drag benefit the government
Fiscal drag means a greater proportion of income is lost in tax, leading to an increase in revenue for the government
Why does the government not give above inflation pay rises to public sector workers during inflation
As a means to tackle inflation, if they raise their wages, this increases AD and therefore worsens inflation
