MACRO Inflation- Deflation Flashcards
Define inflation
Inflation is the persistent rise in the average price level of all goods and services in the economy
Target for inflation
2% (+ / - 1%)
Who controls inflation
•Monetary policy committee @ BOE
•9 people (including Governor Andrew Bailey)
How is it inflation measured?
• Consumer Price Index (CPI)
O Change in price level
O Basket of goods (and service).
• Changed based on changes in spending habits
• Weighted according to spending on each item
CPI limitations
•The CPI is not fully representative:
As it represents changes in costs of an average household it will not be accurate for households who deviate from the average (eg motor expenses not applicable for families without cars)
•The CPI does not account for quality of goods and services
As products increase in price, it may be due to an increase in quality, therefore it makes it hard to compare things like electronics, which have increased in both quality and price, with similar goods available in the past
Explain how rising property prices could cause inflation
Rising property prices➡️
Increased consumer wealth➡️
Demand pull inflation risk➡️
Explain how increasing world oil prices could cause inflation
Increasing world oil prices➡️Higher costs for businesses➡️Cost-push inflation risk
Explain how deprecating exchange rate could cause inflation
Depreciating exchange rate➡️Increased import prices + rising exports➡️Cost-push and Demand pull inflation risk
Explain how Rapid expansion of money and credit from banks could cause inflation
Rapid expansion of money and credit from banks➡️Rising consumer spending financed by loans➡️Demand pull inflation risk
Causes of inflation: Demand pull
- Demand pull inflation
• A rise in the price level caused by an increase in AD
- Any increase in a component of
AD will lead to excess demand that will pull up prices
• In a negative output gap it can have positive effects of raising output and employment to meet
AD
* In a positive output gap it will just fuel inflation so this leads to an increase in monetary rather than real GDP
Causes of inflation: Cost push
- Cost push inflation
A rise in the price level caused by an increase in production costs
• Any increase in ;
• Wages/business rates
• Commodity/oil prices
• Indirect taxes (VAT)
Depreciation of the £
• Introduction of tariffs
• Increase in interest rates
• Firms will pass this cost onto consumers by raising their prices
• By how much depends on PED
• Current UK position
Causes of inflation
Both types can be inter-linked
A rise in the PL caused be excessive demand an lead to higher wage demands by labour /ho want to maintain their standard of living so a wage price spiral leads to cost push inflation too.
Is inflation ever good?
• Workers with strong wage bargaining p
• Debtors if real interest rates are negati
• Producers if prices rise faster than cost
Macroeconomic Policies to Control Inflation
• Fiscal policy: A tightening fiscal policy would include less spending on public and merit goods or welfare payments or raising direct taxes
Monetary policy:
• A ‘tightening of monetary policy’ via higher interest rates or a reversal of quantitative easing or tougher controls on bank lending
• Higher interest rates may cause the exchange rate to appreciate bringing cheaper imported goods and services
• Supply side policies to increase productivity, competition and innovation
Direct controls
• Public sector pay controls e.g. Limiting pay rises for NHS workers
• Capping or other regulation of prices of utilities such as water bills
Describe benign deflation?
PL falls because of a investment leading to productivity improvements resulting in increases in an economy’s LRAS. These result in lower costs for businesses so they can lower prices eg white goods, cars, holidays, high-tech goods etc
Both SRAS and LRAS shift right, PL falls and both output and employment rise
