Inflation

Question 1

What are Administered prices?

Answer 1

Prices set or controlled by government

Question 2

What is Core inflation?

Answer 2

Excludes items from the CPI basket that are highly volatile or prices affected by government policy

Question 3

Explain Cost-push inflation

Answer 3

Occurs when there is an increase in the general price level caused by an increase in the cost of production

Question 4

What is Consumer Price Index (CPI)?

Answer 4

• An index that measures the price of a fixed basket of consumer goods and services
• Relates to the cost of living
• The basket consists of consumer goods and services
• Capital and intermediate goods are excluded
• Prices include VAT
• Interest rates are taken into account
• Prices of imported goods are not shown

Question 5

What is Demand-pull inflation?

Answer 5

Occurs when the demand exceeds the supply of goods and services causing inflation

Question 6

What is Headline inflation?

Answer 6

Unadjusted CPI figures

Question 7

Define Hyperinflation

Answer 7

• An inflation rate above 50%.
• People lose confidence in the value of money and start bartering goods and services

Question 8

Define Inflation

Answer 8

• A sustained significant increase in the general price level over a period of time; and
• a simultaneous decline in the buying power of money

Question 9

What is Inflation targeting?

Answer 9

• Forms part of monetary policy
• Managed by the Reserve Bank to keep inflation within the range as set by the Minister of Finance (between 3% and 6%)

Question 10

What is the Monetary Policy Committee (MPC)?

Answer 10

• Consists of:
• the Governor of the Reserve Bank,
• 3 deputy governors and
• another 3 members.
• Their main purpose is to determine an interest rate in line with the inflation target

Question 11

Explain Producer Price Index (PPI)

Answer 11

Assesses the impact of changes in production inputs:
* Pertains to the cost of production
* The basket consists of goods only
* Capital and intermediate goods are included
* Prices exclude VAT
* Interest rates are excluded
* Prices of imported goods are shown explicitly

Question 12

What is Stagflation?

Answer 12

When:
* Low growth,
* high unemployment
* high inflation rates
occur simultaneously

Question 13

Discuss, in detail, Measuring inflation

Answer 13

1. Indexes: A price index is compiled by using the prices of a representative range of goods and services which are recorded on a regular basis.
2. Weighting: The difference in the importance of items in an index is solved through a weighted index which reflects the relative importance of each item.
3. Inflation rate: The inflation rate is determined by using changes in the CPI and/or PPI index. The figures for each month are compared to the corresponding month in the previous year.
4. Inflation targeting: Forms part of monetary policy set by government and is managed by the Reserve Bank to keep inflation within the range as set by the Minister of Finance (between 3% and 6%). The aim of inflation targeting is to keep the inflation rate at low and more stable levels.

Question 14

Explain, in detail, 3 types of consumer inflation

Answer 14

• Core inflation:
• published by Stats SA
• excludes items from the CPI basket with highly volatile prices and those affected by government intervention and policy,
• e.g. fresh and frozen meat and fish, vegetables, interest rates on mortgage bonds, VAT and assessment rates.
• Headline inflation:
• measured by the CPI and is calculated for urban areas only.
• It represents the cost of a shopping basket of goods and services of a typical SA household.
• The unadjusted CPI rate is known as headline inflation.
• Administered prices:
• the prices are set by government or controlled by government through appointed authorities.
• Price changes must remain within the inflation target prescribed by the Minister of Finance.

Question 15

Discuss, in detail, Producer inflation

Answer 15

• PPI is used to measure the prices of domestically produced goods.
• It also shows domestic output.
• When the rand depreciates it will first be reflected in the PPI.

Question 16

What are the Differences between CPI and PPI?

Answer 16

CPI:
* Pertains to cost of living
* Basket consists of consumer goods and services
* Capital and intermediate goods are excluded
* Prices include VAT
* Interest rates are included
* Prices of imported goods are excluded

• PPI:
• Pertains to cost of production.
• Basket consists of goods only.
• Capital and intermediate goods are included.
• Prices exclude VAT.
• Interest rates are excluded.
• Prices of imported goods are shown explicitly.

Question 17

Explain, in detail, All-inclusive inflation

Answer 17

• Economists check what happened to prices of all final goods and services produced in a particular year.
• Use the calculated implicit GDP deflator.
• Implicit GDP deflator is the ratio of GDP at current prices to GDP at constant prices.
• GDP figures at current and constant prices are used and published in the national accounts.
• GDP at constant prices measures economic growth and measures inflation.
• Measures the inflation rate for economy as a whole.
• To determine inflation:GDP deflator for next year/ GDP deflator for previous year× 100.

Question 18

Describe, in detail, Hyperinflation

Answer 18

• Very high rate of inflation (more than 50%).
• People lose confidence in the value of money.
• Becomes difficult for economy to operate.
• People resort to bartering

Question 19

Comparison of inflation rates

Answer 19

• Annual inflation rates of CPI, PPI and GDP deflation are provided.
• For policy purposes and forecasting all these indexes as well as other implicit deflators are considered.
• The CPI is by far the most important indicator for the consumer because it relates to their cost of living and the interest rate of the Reserve Bank.

Question 20

What are the causes of inflation?

Answer 20

• Demand-pull inflation
• Cost-push inflation

Question 21

Discuss, in detail, demand- pull inflation

Answer 21

• When demand is more supply, causing an increase in the general price level.
• Groups that are responsible:
• Consumers,
• businesses
• government.
• Foreigners’ contribution: They further increase the demand for our goods and services through an increase in exports.
• Decline savings: if savings habits are changed and consumers start spending their savings, growth in aggregate demand can outstrip growth in aggregate supply
• Tax reduction: If personal income tax is reduced more money is available for private consumption expenditure.
• Access to credit: Greater availability of consumer credit (credit cards) and cheaper credit – credit multiplier kicks in and more credit is created.

Question 22

What are the causes of demand-pull inflation?
GITIE

Answer 22

• Increase in household consumption: due to easily available credit, a reduction in taxes and less savings.
• Investors expenditure: may lead to higher profit expectations of businesses - they will invest more, this might lead to an increase in the demand for goods and services.
• Government expenditure: an increase in government spending leads to an increase in prices. More money comes into circulation due to an increase in spending on infrastructure, consumption spending and social spending.
• Export earnings: the growth in foreign countries might create an increased demand for locally produced goods without an increase in production.
• The Monetarist explanation: According to the monetarists sustained high rates of growth in the money supply cause high inflation, while low rates of growth cause low inflation

Question 23

Describe, in detail, Cost-push inflation

Answer 23

• Cost-push inflation is caused by an increase in the cost of goods or services that are very important to the economy, and for which no alternatives exist.
• Examples can be spikes in the oil price due to war, huge price rises in essential food products due to drought, or excessive increases in the cost of labour due to control of industries by trade unions.
• Some of the characteristics of cost-push inflation are:
• An increase in labour costs: Aggressive trade union negotiations push the price of labour up above the increase in productivity.
• Producers increase profits: Prices rise more than the rise in production costs.
• The state imposes a higher VAT rate.
• Expensive imported products (intermediate goods) cause an increase in the prices of locally finished goods.
• Lower productivity but the same remuneration: The cost of production increases.
• Natural disasters: Floods or droughts increase the cost of production.
• Increased total costs on the supply side.

Question 24

What are the Causes of cost-push inflation?

Answer 24

• Wages: an increase in wages constitutes 50% of GVA at basic prices and is one of the major causes of cost-push inflation.
• Key inputs: When the prices of key input goods that are imported, increase, domestic cost of production increases especially in the manufacturing sector.
• Exchange rate depreciation: The depreciation in the rand will lead to more expensive imports.
• Profit margins: When businesses increase their profit margins, their cost of production and prices consumers must pay, will also increase.
• Productivity: Less productive factors of production will lead to increased cost per unit.
• Natural disasters: Prices will increase due to weather changes such as droughts, floods and global warming.

Question 25

Discuss, in detail, Inflationary expectations

Answer 25

• (during inflation) consumers expect prices to rise and start to buy more goods
• labour unions wish to protect their members’ income against erosion of purchasing power caused by inflation
• expectation that wages will rise encourages some businesses to increase prices in advance.

Question 26

What are The consequences of inflation?
TWIDD

Answer 26

• Tax payers: In South Africa income is taxed on a progressive system - experience a bracket creep
• Wage and salary earners: people with a fixed income will be able to purchase less as prices are rising.
• Investors and savers: Assets with a fixed nominal value have a lower purchasing power as prices increase. (Real value of savings decreases.)
• Debtors/Creditors: debtors benefit because they receive money with a high purchasing power and repay their debt with money with low purchasing power. Creditors on the other hand suffer.
• Disruption of industrial peace: Wage bargaining is accompanied by strikes and mass action.

Question 27

What Measures can be taken to combat inflation?

Answer 27

Policy makers can use various policy measures to fight inflation when it gets too high. Three types of policy measures are highlighted:
* Fiscal policy
* Monetary measures
* Other measures

Question 28

Explain what is meant by Fiscal measures in regard to inflation?

Answer 28

Fiscal measures are measures taken by the Minister of Finance regarding taxation and expenditure. Examples of measures that can be taken include:
* An increase in direct taxation (personal income tax) which will help decrease demand.
* An increase in indirect taxation (VAT) causes spending to decrease because goods become more expensive.
* A loan levy- Reduces the disposable income of consumers.
* The state cuts back on expenditure by cancelling government projects like roads, hospitals and schools.
* The country’s finance budget deficit is non-inflationary (the government uses loans from the non-banking sector to limit inflation).
* The state imposes surcharges on imported goods. This increases the price of these imported goods, resulting in many people being unable to afford to buy these goods.

Question 29

Discuss Monetary measures in regards to inflation

Answer 29

The South African Reserve Bank (SARB) and the government apply certain monetary measures to curb inflation:
* The SARB adjusts the quantity of money to the needs of the economy,
* e.g. through open-market policy, thus maintaining a fine balance between the supply of goods and services and money supply.
* The SARB curbs inflation caused by excess demand by reducing the money supply.
* The bank rate of the central bank (SARB) affects the interest rates - can be raised to encourage savings.
* Excessive credit can be reduced by restricting the granting of credit by banks.
* The SARB can apply moral pressure (moral suasion) on financial institutions to be more careful when granting credit.

Question 30

What is meant by Other measures in regards to combatting inflation

Answer 30

Additional measures that can be taken to combat inflation include:
* Increase productivity: This is a long-term measure generated through improved education and training which allows more people to be employed
* Price control: By fixing the price of certain essential goods, the government assures they remain affordable.
* Wage policy: The government makes a decision to break the inflationary spiral of increased wages and prices by keeping the increase in wages below or at the level of inflation.
* Stricter conditions for consumer credit: The government makes it harder for consumers to get credit in order to restrict their spending.
* Encourage personal savings: The government implements measures to encourage savings, e.g. by cutting taxes on savings. The imbalance between demand and supply is corrected by increased savings, as people save more and spend less.
* Import controls are relaxed.
* Floating exchange rate: Prices are automatically adjusted to international conditions.
* Indexation: A policy of linking prices of items such as wages, pensions and mortgage bond interest rates to price indicate in order to eliminate the effects of inflation.