Inflation

• What is the definition of inflation?

  Steady rise in general price level
• How is inflation measured?

  Using the Retail Price Index (RPI)
• What does the Retail Price Index (RPI) track?

  Changes in prices of a "basket" of goods
• What are the main causes of inflation?

  • Demand-Pull Inflation
  • Cost-Push Inflation
  • Imported Inflation
• What causes Demand-Pull Inflation?

  Increased aggregate demand
• When does Demand-Pull Inflation occur?

  When demand outpaces supply
• What is Cost-Push Inflation caused by?

  Increased production costs
• What is the wage-price spiral?

  Rising wages drive prices higher
• What is imported inflation?

  Inflation due to reliance on imports
• How do rising global prices affect domestic inflation?

  They contribute to domestic inflation
• What are the consequences of inflation?

  • Reduced purchasing power for fixed income earners
  • Higher domestic prices reduce export competitiveness
  • Borrowers gain, creditors lose in real terms
  • Increased business costs (shoe leather and menu costs)
  • Potential layoffs due to rising labor costs
• How does inflation affect fixed income earners?

  It reduces their purchasing power
• What happens to trade deficits during inflation?

  Higher prices reduce export competitiveness
• How do borrowers benefit from inflation?

  Real value of debt decreases
• How do creditors lose during inflation?

  Repayments are worth less in real terms
• What are shoe leather costs?

  Increased effort to find better prices
• What are menu costs?

  Costs of frequent price adjustments
• How can rising costs affect businesses?

  May force businesses out of the market
• What can rising labor costs lead to?

  Potential layoffs in businesses
• What measures can be taken to reduce inflation?

  • Demand-Pull Inflation:
  • Deflationary fiscal policies
  • Deflationary monetary policies
  • Cost-Push Inflation:
  • Limit trade union power
  • Provide subsidies
  • Imported Inflation:
  • Substitute imports with local goods
  • Reduce reliance on foreign materials
  • Monetary Supply Inflation:
  • Tighten monetary policies
• What fiscal policies can reduce Demand-Pull Inflation?

  Reduce government spending and increase taxes
• What monetary policies can reduce Demand-Pull Inflation?

  Raise interest rates and limit borrowing
• How can Cost-Push Inflation be addressed?

  Limit trade union power over wages
• What can be done to reduce Imported Inflation?

  Substitute imports with locally-produced goods
• How can monetary supply inflation be controlled?

  Tighten monetary policies and raise interest rates