Inflation

• What does the 'headline' rate of inflation represent?

  Annual % change in the CPI
• What does the Consumer Price Index (CPI) track?

  Changes in prices of a basket of goods
• How is CPI expressed?

  As an index number
• What is the formula for calculating CPI inflation?

  CPI Inflation Rate = [(Current CPI - Previous CPI) / Previous CPI] × 100
• What does the basket of goods and services represent?

  Things a typical household buys
• How often is the price survey for the basket conducted?

  Each month
• How are the prices of goods/services in the basket weighted?

  According to household income spending proportions
• What does CPIH include that CPI does not?

  Owner occupier housing costs
• What is the Retail Price Index (RPI) used for?

  Calculating increases in welfare benefits and pensions
• What does 'core' inflation exclude?

  Energy, food, alcohol, and tobacco
• What is inflation?

  A sustained increase in the general price level
• What is deflation?

  A sustained decrease in the general price level
• What is disinflation?

  A reduction in the rate of inflation
• What does the cost-of-living measure represent?

  Changes in average costs for households
• What is the inflation target set by the UK government?

  CPI inflation = 2% +/- 1% point
• What are shoe leather costs?

  Costs of shopping around when prices change
• What are menu costs?

  Costs of redoing price labels and lists
• What happens to real incomes if wages do not keep pace with prices?

  Real incomes fall
• How can inflation create uncertainty?

  It may reduce consumer and business spending
• What are redistributional effects of inflation?

  Lower real returns for savers and fixed incomes
• How does inflation affect international competitiveness?

  Exports become more expensive, imports cheaper
• What happens to inflation expectations during high inflation?

  People aim for bigger pay rises
• What is the danger of a wage-price spiral?

  Workers demand big pay rises, increasing costs
• What are the benefits of a low rate of inflation?

  • Implies aggregate demand exceeds aggregate supply
  • Reduces the real value of debt
  • Allows negative interest rates
  • Helps labor markets function efficiently
  • Makes malign deflation less likely
• What are the limitations of the CPI inflation measure?

  • Calculated for an 'average' family
  • Does not consider quality of goods/services
  • Needs regular updates for spending patterns
  • International comparisons may be inaccurate
• What do monetarists argue causes inflation?

  Excessive growth of the money supply
• What is demand-pull inflation?

  Inflation caused by excess aggregate demand
• Producers can raise prices and increase their profits during demand pull inflation
• What is cost-push inflation?

  Inflation caused by increases in production costs
• What can cost-push inflation lead to?

  Stagflation when the economy stagnates as price level rises
• What are some causes of demand-pull inflation?

  Lower interest rates, Rapid income growth, Lower income tax, Higher consumer confidence, Positive Wealth effects, Depreciation of the currency, Easy credit (Cheap and accessible credit)
• What is anticipated inflation?

  Inflation expected by economic agents
• What is unanticipated inflation?

  Inflation that comes as a surprise - ; the costs of inflation to economic agents are higher when there is an inflation shock eg a sudden sharp increase in energy or food prices
• What can help with inflationary expectations?

  Having an inflation target
• What causes malign deflation?

  Negative demand shocks and global recession
• What is benign deflation?And the causes

  Deflation caused by increases in aggregate supply

  Technological advances • Improvements in productivity • Falling price of commodity prices • Falling price of energy prices • Globalisation/economies of scale • Cheaper/more skilled labour (perhaps from immigration)
• What are some costs of deflation?

  Lower AD causes over supply • Lower prices for goods and services cuts cash flow and profits for businesses; consumers may delay their spending; businesses may cut investment • Businesses reduce production; cyclical unemployment rises • Rise in real value of debt • Real interest rates may rise reducing consumption and investment
• What are some benefits of deflation?

  Falling prices for consumers • Increase in real incomes • Increased spending power for those on fixed incomes • Improved international competitiveness • Falling asset prices make housing more affordable for first time buyers
• How does deflation affect spending power?

  Increases spending power for fixed incomes
• How does deflation improve international competitiveness?

  Falling prices make exports cheaper