Inflation and deflation Flashcards
What is demand-pull inflation?
caused by excess aggregate demand for goods and services. demand side of the economy
causes of demand-pull inflation:
- lower income tax: increases disposable income of households
- lower interest rate: borrowing more attractive and saving less rewarding
- a general rise in consumption: higher incomes and consumer confidence
- improved availability of credit/money supply: credit boom leading to borrowing -> consumption and investment
- a weak exchange rate: will boost export growth
- fast growth in other countries: increase demand for uk exports
- general rise in confidence/expectation of future growth: higher compensation and investment
- certainty: confidence and assists consumers and firms in their consumption and investment decisions
what is cost-push inflation?
occurs when firms respond to rising costs of production by increasing prices
causes of cost-push inflation:
- wages increase
- stronger trade union power
- higher raw material costs
- higher taxes
- higher import prices
- natural disasters
what has led to demand-pull inflation in relation to markets?
emerging markets are creating a growing demand for good and services globally. during recession, UK faces lower inflationary pressure
Peoples expectation of future inflation can affect what?
affect the current rate of inflation. if people expect that the inflation rate next year will be high then:
-trade unions and workers bargain for higher wages
- firms raise prices
their behaviour will deliver higher inflation next year
when inflation is relatively low and stable:
- relatively easy to anticipate next years inflation rate
- associated with growing markets, healthy profits and business confidence
- reduce unemployment
- make labour markets function fully
- allows real wage to fall without cutting nominal wage
winners of high inflation:
- workers with strong wage bargaining power
- debtors if real interest rates are negative
- producers if prices rise faster than costs
losers from high inflation:
- retired on fixed incomes
- lenders if real interest rates are negative
- savers if real returns are negative
- workers in low paid jobs
inflation could make the economy less efficient and competitive through:
- distributional effects
- low or negative real interest rate
- distortion of normal economic behaviour
- breakdown in the functions of money
- lack of international competitiveness
- shoe leather and menu costs
- business uncertainty
if inflation is caused by excess demand what happens? (policies to control inflation)
rising interest rate is an appropriate policy for controlling inflation
if inflation is caused by external cost pressure what happens? (policies to control inflation)
raising interest rate is not an appropriate policy
inflation can be reduced by policies that slow down the growth of AD or boost the rate of growth of aggregate supply
- monetary policy
- fiscal policy
- supply side policies to increase productivity, competition and innovation
- direct controls
explain the monetary policy in relation to inflation:
- a tightening of monetary policy via higher interest rates or a reversal of quantitative easing or tougher controls on bank leaning
- higher interest rates reduce consumer spending: ^cost of borrowing — discouraging consumers from borrowing and spending — saving becomes more attractive — ! disposable income of those with mortgages — ^ value of exchange rate leaving the lower exports and more imports
fiscal policy in relation to inflation:
- may choose to tighten fiscal policy by reducing its own spending on public and merit goods or welfare payments
- can choose to raise direct taxes leading to a reduction in real disposable income
supply side policies in relation to inflation:
- reduction in company taxes to encourage greater investment
- reduction in taxes which increase risk taking and incentives to work
- privatisation and deregulation would make firms more productive and competitive
what is deflation?
it’s a persistent fall in the general price level of goods and services. the rate of inflation becomes negative.
demand-side causes of deflation:
- deep fall in AD causing a persistent recession/depression
- large negative output gap
- falling real output and rising unemployment
supply-side causes of deflation
- improved productivity
- technology advances
- significant fall in wage rates
- high exchange rate causing important prices to fall
- rising real output and employment
consequences of deflation for individuals and the economy:
- holding back on spending
- debts increase
- the real cost of borrowing increase
- lower profit margins
- confidence and saving
- income distribution
- make exporters more competitive eventually
policies to control inflation:
- low interest rates and a reversal of quantitative easing
- fiscal stimulus measures: higher gov spending, rise in gov borrowing, lower direct tastes to increase disposable income and spending
- other measures to stimulate aggregate demand, attempts to lower the value of exchange rate, higher taxes on savings to encourage consumption
what is deflation?
a persistent fall in the general price level of goods and services, the rate of inflation becomes negative
description of demand-side causes of deflation:
- deep fall in AD causing a persistent recession/depression
- large negative output gap
- falling real output and rising unemployment
description of supply-side causes of deflation:
- improved productivity
- technological advances
- significant fall in wages
- high exchange rate causing import prices to fall
- rising real output and employment
consequences of deflation for individuals and the economy:
- holding back on spending
- debts increase
- real cost of borrowing increases: real interest rates rise
- lower profit margins
- confidence and saving
- income distribution
- exporters more competitive
policies to control deflation:
USE MACRO-STIMULUS POLICIES BY EITHER LOOSENING THE MONETARY POLICY AND/OR FISCAL POLICY
low interest rates and quantitative easing:
- cheaper loans for businesses and households
-expanding supply of credit in banking system
fiscal stimulus measures:
- higher government spending
- rise in government borrowing in inject demand into circular flow
- lower direct taxes to increase disposable income and spending
other measures to simulate aggregate demand:
- attempts to lower value of exchange rate
- higher taxes on savings to encourage consumption
