monetary policy and the price level

Question 1

inflation

Answer 1

a steady and persistent increase in the general level of prices.
It is the rate at which your money loses its ability to buy goods/services

Question 2

deflation

Answer 2

there is a general decrease in the average level of prices

very damaging to an economy

Question 3

effects of deflation

Answer 3

-consumers may postpone buying goods/services as they expect prices to continue to fall
therefore demand has fallen, which affects employment and growth

Question 4

measure of inflation

Answer 4

simple price index

price in any year / price in base year x100

Question 5

composite price index

Answer 5

examines changes in the general price level ie many goods

takes into consideration the importance of the amount of money spent on each good (weights)

Question 6

steps of finding the composite price index

Answer 6

1. choose a base year and let all the prices equal to 100
2. select the goods and find their prices in all years
3. construct a simple price index for each good
4. multiply the simple price index by the weight
5. add to get the composite price index for the current year

Question 7

consumer price index

Answer 7

measures the overall change in the prices of goods and services that people typically buy over time.
It does this by collecting approx. 53,000 prices every month and comparing these to the corresponding prices from the previous month

Question 8

the household budget survey

Answer 8

carried out every 5-7 years to find out the fraction of income spent on items
carried out to get accurate details of consumer spending patterns

Question 9

economic uses of CPI

Answer 9

-maintaining the real value of social welfare payments eg pensions
-international comparisons: comparing our rate of inflation with abroad shows whether
our international competitiveness is improving or disproving

Question 10

government can improve Irish international competitiveness by

Answer 10

negotiating wage agreements
reducing utility charges
reducing VAT
reducing employers PRSI
improving infrastructure

Question 11

precautions to take when using CPI

Answer 11

• index of only the average consumer
• not a cost of living index
• lags behind consumer trends and fashions
• static weights
• quality changes in products

Question 12

what factors cause inflation

Answer 12

demand pull factors:
-if aggregate demand is greater than a. supply, prices go up
cost push factors:
-increase in the cost of production -> pass this on to selling price
imported inflation:
-cost of imported raw materials increases -> pass this on to selling price
government induced inflation:
-gov. decided to increase VAT, or reduces income tax. which increases demand pull inflation

Question 13

harmonised index of consumer prices

Answer 13

compares the rates of inflation in euro areas, the EU, the European economic area and other countries
calculated in a harmonised approach, ie same method for each country

Question 14

similarities between CPI and HICP

Answer 14

purpose:
-both measure the change in the average level of prices of a fixed basket of consumer goods and services
reference population:
-includes all private households, foreign tourists on holidays and all institutional households
methodology:
-both use the same methods in compiling and aggregating the component price indices, following EU regulations by Eurostat

Question 15

differences between CPI and HICP

Answer 15

date of introduction:
CPI march 1922
HICP 1996

measure of consumer price inflation:
CPI is the official measure in Ireland
HICP enables international comparisons

base reference period:
CPI: december 2011 = 100
HICP: 2015 = 100

Question 16

monetary policy

Answer 16

the way in which the central bank affects the amount of money in circulation

Question 17

ECB role

Answer 17

maintain price stability in the euro area and so preserve the purchasing power of the single currency

Question 18

how does the ECB implement monetary policy within the eurozone countries

Answer 18

• monitors the growth of money supply
• engages in open market operations
• sets interest rates
• uses standing facilities: marginal lending facility and deposit facility
• ensures minimum reserve requirements

Question 19

demand pull inflation

Answer 19

due to:

• goods cannot be manufactured/imported quick enough to meet demand
• unexpected increase in consumer confidence
• firms with monopoly power take advantage and increase prices

Question 20

cost push inflation

Answer 20

due to:

• increased wage demands due to the minimum wage/social partnership agreements
• increased prices for imported raw materials
• imported inflation
• value of the euro falls
• increased cost of homemade raw materials
• increased costs of production

Question 21

factors that cause inflation

Answer 21

-imported inflation
-government induced inflation due to:
increased VAT
knock on effect for wage increases
lowering income tax

Question 22

economic effects of inflation

Answer 22

production may be encouraged
consumption may be encouraged
lower standard of living
increase in unemployment
borrowing is encouraged
saving is discouraged

Question 23

remedies to reduce inflation

Answer 23

-fiscal policy:
increase direct/indirect taxation
encourage savings
reduce gov. spending
-monetary policy
availability of credit
interest rates
-partnership agreements for low pay increases
social welfare/pensions

Question 24

dangers of hyperinflation

Answer 24

money loses its value when alternative methods of exchange are used (barter or foreign currency)

Question 25

deflation

Answer 25

there is a general decrease in the average level of prices

causes a decrease in demand/investment

Question 26

deflation may be caused by

Answer 26

• over supply in relation to demand
• a sudden drop in demand, investment, gov spending
• persistent unfavourable balance of payments

Question 27

positives of deflation

Answer 27

• increase in the purchasing power of money
• gov can save money on capital projects
• increased national competitiveness

Question 28

benefits of price stability

Answer 28

• demand for wage increases wont be as urgent as purchasing power isn’t falling
• OAPs and those on fixed incomes will have their purchasing power maintained, managing their finances better
• savings may increase, particularly if the rate of inflation is higher than the rate of savings