Inflation

• Inflation


  The persistent rise in the average or general price level
• Inflation is generally quoted in percentage points annually
• Types of Inflation


  • Hyperinflation
  • Stagflation
• Hyperinflation


  Extremely high rates of inflation, i.e. thousands of %
• Stagflation


  High inflation accompanied by high unemployment
• Absolute price


  The number of dollars that can be exchanged for a specified quantity of a given good
• Relative price


  The quantity of some other good that can be exchanged for a specified quantity of a given good
• The change in relative prices is not the same thing as changes in absolute prices
• Nominal wage


  The actual wage earned, the dollar amount paid to workers in exchange for their labour services
• Real wage


  The purchasing power of a worker's nominal wages, the number of goods and services a person is able to afford from his or her earnings
• Inflation


  Increases nominal interest rates
• Headline inflation


  A measure of the total inflation within an economy, including commodities such as food and energy prices
• Core inflation


  A measure of inflation that excludes items with volatile price movements
• Deflation


  Occurs when prices are falling (inflation is negative)
• Nominal GDP


  A measure at current prices
• Real GDP


  Measured at constant prices, adjusted for inflation
• Retail Price Index (RPI)


  The most common index used to measure and evaluate the inflation rate
• Consumer Price Index (CPI)

  A price index which measures the weighted average price changes of a range or 'basket' of goods and services consumed by the average household
• Producer Price Index (PPI)

  Used to measure the changes in the price received by producers for their output
• Limitations in calculating price indices include the difficulty in determining the appropriate weights and the need to frequently update the basket of goods
• Cost-push inflation


  Occurs as increases in production costs are passed on to consumers in the form of higher prices
• Increase in labour costs

  Leftward shift of the AS curve, leading to a fall in output and rise in prices (cost-push inflation)
• Causes of cost-push inflation

  • Rising wages
  • Higher import prices
  • Depreciation of the exchange rate
  • A rise in indirect taxes
• Wage-price spiral


  The tendency for wages to increase and for this increase in wages to fuel price increases, which in turn cause labour to demand even higher wages
• Demand-pull inflation


  Occurs due to increased levels of spending
• Commodities which are imported and cannot be produced domestically would cause a rise in the general price level
• Depreciation of the exchange Rate – A fall in the external price of a country's currency through depreciation would also result in higher prices for imported commodities and thus inflation
• A Rise in Indirect Taxes – This would also result in an increase in firm's costs and thus prompt cost-push inflation in the economy
• Regulations to limit the power of trade unions to increase wages

  Effective in curbing cost-push inflation
• Government subsidies and grants to firms

  Help increase production, making more goods and services available, putting less pressure on prices by increasing overall supply of goods in the economy, even though aggregate demand remains the same
• Demand-pull inflation


  Occurs when the supply capacity of the economy cannot effectively meet the increase in demand generated by an increase in spending
• Aggregate demand increases


  Price level shifts up
• Causes of demand-pull inflation

  • Increases in aggregate spending by government
  • If the rate of investment is greater than the rate of savings, or any injection is greater than a withdrawal, or a combination of all three injections is greater than a combination of all three withdrawals
  • A fall in income taxes that increases disposable income causing consumption to rise
  • Increases in marketing that causes consumers to spend more
• Deflationary fiscal policy


  Reducing government expenditure and increasing taxes to reduce aggregate spending in the economy and reduce pressure on prices
• Deflationary monetary policy


  Higher interest rates and a credit squeeze to limit borrowing and spending, reducing inflation
• Monetary inflation


  Demand driven, associated with 'too much money chasing too few goods'
• Quantity theory of money


  Direct and proportional relationship between changes in the rate of growth in the money supply and corresponding changes in the price level
• An increase in the money supply causes monetary inflation
• Deflationary monetary policy


  Higher interest rate and a credit squeeze both reduce the money supply in the economy, reducing spending and pressure on prices
• Imported inflation is caused by rising world prices of food, finished goods and factors of production, and a depreciation of the exchange rate making imports more expensive