Inflation

• Inflation definition 


  Sustained increase in the general level of prices - causing a fall in the value of money
• Disinflation - definition 


  A period of slower inflation
• Deflation


  Decrease in the general level of prices
• Real Price Index (RPI)


  Calculates the cost of a typical basket of weighted goods. The difference in the price for this basket from year to the next gives the rate of inflation. Includes housing costs
• Does the RPI include housing costs


  Yes
• What is the problem with RPI


  Not representative

  Debates on what should go in the basket for example Gluten free bread a lot more expensive - so they feel the burden of inflation a lot more as it not part of the basket of goods - feel inflation a lot more
• Consumer Price Index (CPI)


  Same basket but excludes housing costs
• What measure of inflation does UK use

  CPI
• Cost-Push-Inflation

  • Caused by the rising costs of inputs/raw materials/commodities
  • Forces producers to charge higher prices to consumers
  • Example: Massive lag in the production of cars due to not enough components coming in from Ukraine - so prices have had to rise to reduce demand
• Demand-Pull-Inflation

  • Caused by the rising demand of goods/services
  • Sellers increase their prices
  • Example: Decreasing interest rates (Cheap to borrow therefore more spending>>>increases demand)
  • Fast growth in other countries - providing a boost to UK exports overseas
  • If taxes are reduced, consumers have more disposable income causing demand to rise - multiplier effect
• Effects of inflation on Firms


  Increase costs of supplies

  Cut back on investment

  Less exports
• Effects of inflation for consumers

  Inflation will erode the real value of money - real incomes will fall, as the purchasing power of incomes falls. So standard of living also falls.

  Inflation rises because the more skilled workers can negotiate nominal wage increases that keep pace or outstrip inflation.

  Cash losses value more quickly - Meaning some consumers take more trips to the banks
• Impact on Savers and Borrowers

  • Savers lose out because the real interest rate falls as inflation rises
  • Borrowers gain because the real interest rate falls
  • indebtedness falls because the real value of debt falls as inflation erodes the real value of repayments
• Negative effects of high rates of inflation on Government

  1. Pressure to raise the value of state welfare benefits
  2. High inflation can cause GDP growth to slowdown - leading to lower tax revenues and increased borrowing
  3. Increased market rates making gov borrowing more expensive
  4. Worsening of international competitiveness causing a fall in exports which can threaten jobs and forecast GDP Growth
• Positive effect of high inflation on Government

  1. Can lead to fiscal drag - causing them to pay more direct and indirect taxation
  2. cause a reduction in the real value of government existing/outstanding debt
  3. Real interest rates on borrowing money might be negative
  4. Moderate positive inflation helps business to make higher profits - generating more tax for gov
• Limitations of CPI


  Prone to inaccuracy/errors - Like all data collection schemes, CPI is prone to errors and inaccuracies. This can result in the inflation rate being either undervalued or overvalued. Can be a major problem when considering policy decisions can be made based upon the inflation rate of the economy
• Limitation of CPI


  Different measurements of inflation are used by different countries – Other countries may use different inflation measurements such as RPI. For example, CPI is often less than RPI as it doesn’t include housing costs and therefore this can make comparisons between countries using different inflation measurements difficult to make.