Inflation and Deflation

• What is inflation?

  The sustained rise in the general level of prices of good and services over time, as measured by a consumer price index
• What is hyperinflation?

  Very high rates of inflation that are out of control, causing average prices in the economy to rise very rapidly
• What is the Consumer Price Index?

  Weighted index of consumer prices in an economy over a period of time, used to measure cost of living for an average household
• What is deflation?

  Sustained fall in general price level in an economy over time
• What causes benign deflation?

  Caused by higher levels of supply of goods and services, thus increasing productive capacity of the economy which drives down general price level whilst increasing national income
• What causes malign deflation?

  Caused by lower levels of demand in an economy, thus driving down general price level due to excess capacity in the eocnomy
• What is the base year?

  Refers to starting year when calculating a price index
• What is cost-push inflation?

  A type of inflation caused by higher costs of production which forces up prices
• What is demand-pull inflation?

  A type of inflation caused by higher levels of demand in the economy, thus driving up the price level
• What is imported inflation?

  A type of inflation caused by higher import prices of goods and services in an economy over time, raising production costs so fuels domestic inflation
• Consequences of Inflation:

  • Households: Declining real income
  • Menu and Shoe Leather costs
  • Savers: Lose from declining real interest rates
  • Lenders: Lose from lower real interest rates
  • Borrowers: Gain from lower real interest rates
  • Exporters lose, importers gain
  • Employers: Workers demand pay raise, higher costs of production
  • Business confidence levels: Causes uncertainty, lowers investment
• Consequences of deflation:

  • Unemployment
  • Bankruptcies
  • Declining wealth
  • Higher real value of debts (borrowers lose)
  • Government budget deficits
  • Declining consumer and producer confidence
• What is disinflation?

  Occurs when inflation rate falls, but is still positive
• What is reflation?

  Occurs when rate of inflation increases
• What is the wage-price spiral?

  Occurs when trade unions negotiate higher wages due to inflation