Inflation and Deflation Flashcards
What is inflation?
Rate of change in the average price level over time, sustained increase in the cost of living, fall in the purchasing power of money.
Macroeconomic objective: 2% (+/- 1%)
What does the Consumer Price Index (CPI) measure?
Family expenditure survey to judge average spending habits, regularly updated basket of goods, attaches weights to items based on importance in spending.
Representative of consumer spending patterns.
What is a limitation of the CPI?
Households experience different rates of inflation, doesn’t recognize improvements in quality of goods, slow to respond to new products.
For example, spending patterns differ depending on family size.
What does CPIH include?
CPI plus owner-occupier housing costs, judged using a rental equivalence approach.
Reflects costs associated with owning, living, and maintaining a home.
What is the Retail Prices Index (RPI)?
Includes mortgage interest repayments and Council Tax, tends to be higher than CPI, excludes top and bottom 4% of the population.
Discredited as a measure due to distortion from mortgage payments.
What are the causes of inflation?
Demand-Pull and Cost-Push factors.
Demand-Pull factors include excess demand, reduced taxation, and lower interest rates. Cost-Push factors include rising production costs and external shocks.
What does the Quantity Theory of Money state?
Growth of the money supply leads to inflation.
Milton Friedman stated, ‘Inflation is always and everywhere a monetary phenomenon.’
How can the money supply be increased?
Printing more notes, reducing deposit holdings of banks, quantitative easing (QE).
QE involves buying back bonds from the market.
What does the Fisher Equation represent?
MV = PQ, where M is money supply, V is velocity of circulation, P is average price level, and Q is national income/output/expenditure.
What happens to price level if money supply (M) doubles while V and Q remain constant?
Price level (P) will double.
Based on the Fisher Equation: P = MV/Q.
What are problems with the Quantity Theory of Money?
Changes in V and Q can influence inflation, other causes of inflation exist, difficult to quantify M.
What are the costs of inflation?
Reduced confidence, decreased real value of savings, income redistribution, harms trade, wage-price spiral, usually higher interest rates, menu and shoe leather costs.
What are the benefits of inflation?
Sustainable inflation suggests growth, reduced risk of deflation, erodes the real value of debts.
What is deflation?
Decrease in the general price level.
Consequences include holding back on spending and lower profit margins.
What is malignant deflation?
Persistent fall in prices due to decreased aggregate demand (AD).
What is benign deflation?
Fall in prices due to outward shifts in short-run aggregate supply (SRAS).
What is imported inflation?
Changes in world commodity prices affecting domestic inflation.
Commodities like oil and food significantly impact UK imports.
What should be evaluated regarding inflation’s impact on macroeconomic objectives?
Evaluate the impact of rising inflation on two macroeconomic objectives, explain the relationship, and discuss influencing factors.
True or False: Lower inflation is most likely to be achieved with an increase in consumption.
False.
If the CPI rises from 100 to 105, what does this indicate?
The average price level has increased by 5%.
