Macro 7 - Inflation Flashcards
Inflation definition
Sustained increase in the average price level across the economy
What are sustained periods of extremely high inflation?
Hyperinflation
What is deflation?
Sustained decrease in the average price level across an economy
Why is low and stable inflation an important macroeconomic objective?
Limit high prices for Firms and Households
Limit income inequality
What is the UK government’s target inflation rate?
2% CPI
Why is the inflation target not 0?
Because inflation indicates economic growth
Why is deflation sometimes perceived as bad for an economy?
Could be an indication that the economy is slowing
Deflation leads to people waiting for prices to fall more, which leads to lower spending and low growth, which results in a deflationary cycle
Disinflation definition?
Decrease in the rate of inflation
Is -0.5% inflation rate disinflation or deflation?
Deflation
When measuring inflation, why do economists use index numbers?
Because they are easier to analyse
When measuring inflation, how are index numbers calculated?
A base period must be assigned to which the rest of the data will be compared. The base year is assigned a value of 100
When measuring inflation, after assigning a base year with a value of 100, how is the remaining data expressed?
(New value ÷ Base year value) x 100
How are measures of inflation calculated?
Using a basket of goods, where each good is given a weighting depending on the proportion of income it takes up.
Why does the changing of weights of goods happen in the CPI basket of goods?
Changes in weights reflect shifts in the spending patterns of households in the UK economy.
How is inflation measured in the UK?
Through the Consumer price index (CPI)
Why did the UK Government change the Inflation measurement to CPI?
To join the Harmonised Index of Consumer Prices (HICP) to make it easier to compare inflation levels with other countries
What are the steps to organise the basket of goods used to measure inflation?
- The top 650 goods and services consumed in the UK are chosen
- Each good is assigned a weight depending on the proportion of income they take up
What is the formula to calculate the rate of inflation using index numbers?
((New price level - Old price level) / Old price level ) x 100
For example, if prices on average in the economy were 5.70 GBP in 2014 and rose to 6 GBP in 2015, then the index formula to calculate inflation can be used:
6/5.7 x 100 = 105.3
= 5.3% Inflation rate
The price index for 2016 is 105, and the price index for 2017 is 110, how is the rate of inflation calculated?
(110 - 105 / 105 ) x 100 = 4.8%
What are the 2 ways of measuring inflation?
Retail price index (RPI)
Consumer price index (CPI)
What does CPI exclude from it’s data?
mortgage interest payments, rent and council tax
Does interest rates affect RPI?
Yes, because it includes mortgage interest payments
What households does RPI exclude?
highest income households
What are the advantages of excluding mortgage interest payments from measures of inflation?
If mortgage interest rates are excluded, then inflation will be lower if interest rates are low
What are the disadvantages of excluding mortgage interest payments?
If Bank of england raises Interest rates, then inflation would be higher, making the government look worse
What is RPIY?
RPI - Mortgage interest payments + Indirect taxes
What is RPIY used for?
RPIY is used to measure core inflation, excluding food and energy prices
Why is RPIY useful?
Food and energy prices are very volatile and economists want to compare rates of inflation effectively.
Why might not CPI or RPI accurately measure inflation?
Not everybody spends their money on the same goods and services
What is the ONS?
Office for national statistics, who measure inflation
What is the difference between real and nominal values?
Real - Adjusted for inflation
Nominal - Includes inflation
If nominal GDP rises by 2%, but inflation is 8%, what is the increase in real GDP?
2% - 8% = -6% in real GDP
how to find real interest rate / GDP?
Nominal value - Inflation rate = real value
What’s the significance of real interest rates?
Savers do not benefit if real interest rates are negative
Borrowers benefit if they are negative
What is the significance of using real vs nominal values when evaluating the impact of increases in Government spending?
Government spending (G) is only beneficial after being adjusted for inflation
