Inflation Flashcards
What is inflation
A sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money
How is the rate of inflation measured
Annual % change in consumer prices
What is the uk government’s inflation target
2%
Who helps control inflation rates
The Bank of England sets monetary policy interest rates so that inflationary pressures are controlled and the inflation target is reached
What is deflation
Rate of inflation is negative
What is disinflation
Fall in the rate of inflation
What is hyper-inflation
A period of very high rates of inflation, usually leading to a loss of confidence in an economy’s currency
What is the inflation rate
The annual rate of change of the average price of goods and services
What are unit labour costs
They reflect labour costs, including social security and employers’ pension contributions, and including the costs of self-employed labour, incurred in the production of s unit of economic output
What is the consumer price index
A measure of the price level based on the prices of a collection of products designed to reflect the consumption basket of the average consumer
How is the rate of inflation calculated (CPI)
- a base year is selected and an expenditure survey carried out
- basket of goods (weights attached to each item based on their importance)
- weights are multiplied by brand changes
How many people do they base year survey for CPI
40,000
How do you calculate the price index for a year
Sum of (price x weight) / sum of the weights
Limitations of the CPI as a measure of inflation
- not representative of ‘non-typical’ households
- some people have different spending patterns
- changing quality of goods and services
- new produced each year
What changes yearly with the CPI
The basket of goods - to represent changes in preferences and needs
CPI rates U.K.
Increasing over time
What are the main causes of inflation
- demand and supply sides
- internal and external events
Internal and external causes of inflation
- domestic economy (e.g. rise in VAT)
- external sources (e.g. rise in commodities)
When does demand pull inflation occur
When aggregate demand is growing at an unsustainable rate = increased pressure on scarce resources and a positive output gap
When does demand pull inflation become a threat
When an economy has experienced a boom with GDP rising faster than the long-run trend growth of potential GDP
When is demand pull inflation likely to occur
When there is full employment of resources and SRAS is inelastic
What are the main causes of demand pull inflation
- depreciation of the XR
- higher demand from fiscal stimulus
- monetary stimulus
- fast growth in other countries
How does a depreciation of the XR create demand pull inflation
Increases the price of exports and reduced the foreign price of a country’s exports. If consumers buy fewer imports, while exports grow, AD in will rise - and there may be a multiplier effect on the level of demand and output
When does cost-push inflation occur
When businesses respond to rising costs, by increasing pricing to protect their profit margins
Why might costs for businesses rise (causing cost-push inflation)
- component costs
- rising labour costs
- expectations of inflation
- higher indirect taxes
- fall in the XR
- monopoly employers / profit-push inflation
Expectations of inflation
- difficult to remove once established
- most people will raise their inflation expectations and build it into their decisions
- increase in inflation expectations
What are internal causes of inflation
- surge in property prices
- higher wages / cost of labour
- book in credit / money supply
- rise in business taxes
What are the external causes of inflation
- increase in world oil / gas prices
- inflation in global commodity prices
- depreciation of the XR
- high inflation in other countries
Consequences of inflation for consumers, business, the government and workers
- income redistribution
- falling real income
- negative real interest rates
- cost of borrowing
- risks of wage inflation
- business competitiveness
- business uncertainty
Winners of inflation
- workers with strong wage bargaining power
- senators if real interest rates are negative
- producers if prices rise faster than costs
Losers of high inflation
- retired on fixed incomes
- lenders if real interest rates are negative
- savers if real returns are negative
- workers in low paid jobs
Why is the rate of inflation difficult to forecast accurately
- volatile global energy prices
- changes in value of the currency
- uncertain growth of AD
- volatile food prices
- government indirect taxes can change
How can inflation be reduced
Policies that slow AD or boost AS
How can fiscal policy help reduce inflation
Tighten fiscal policy
- reducing spending on public and merit goods or welfare payments
- raise direct taxes
How can monetary policy reduce inflation
Tightening of monetary policy
-higher interest rates
(May cause the XR to appreciate in value)
How can supply side policies reduce inflation
Increase productivity, competition and innovation - all of which maintain lower prices
How can direct controls reduce inflation
Controls on some prices and wages
What is the best way to control inflation in the short term
For the government and the central bank to keep control of AD to a level consistent with out productive capacity
When is controlling demand to limit inflation likely to be ineffective in the short run
If the main causes are due to external shocks such as high world good and energy prices
