Pros + Cons, Measurements, Definitions

• inflation defintion

  a sustained increase in general price level
• deflation definition

  a sustained decrease in general price level
• disinflation definition

  reduction in the rate of inflation (the inflation rate falls but the price level is still rising)
• cost of living

  measure of changes in the average cost for a household of buying a basket of different goods and services
• inflation target

  the target set by the government which the central bank should aim to achieve, e.g. in the UK, its 2%
• formula for CPI

  CPI inflation rate = [(Current CPI-previous CPI)/Previous CPI] x 100
• what is the CPI

  consumer price index tracks changes in the prices of a basket of goods and services purchased by an average household. It is expressed as an index number
• RPI defintion

  Retail price index, includes further "goods" such as council tax and mortgage interest payments. Often used to calculate increases in welfare benefits, pensions, index-linked bonds and wage negotiations. Typically gives higher inflation than CPI
• Core inflation

  excludes goods from the basket, such as energy, food, alcohol, and tobacco, which can be volatile.
• Limitations of CPI inflation measure

  • only calculated for average family
  • does not consider quality of goods/services
  • needs regular updating to reflect patterns of spending
  • international comparisons may differ if other countries measure inflation differently
• Negatives of inflation

  -uncertainty (inflationary noise)

  -fall in real income

  -menu costs (redoing menus, price labels etc)

  -loss of international competitiveness

  -wage-price spiral

  -redistributional effects, savers get lower rate of return, fixed incomes lose etc.
• Benefits of low inflation rate

  -reduce real value of debt

  -allow negative interest rates

  -makes malign deflation less likely

  -labour markets work more efficiently without needs to cut nominal wages

  -implies AD is ahead of AS, incentivising investment and growth