Inflation And Deflation Flashcards
Define inflation and how is it controlled
General rise in price levels of g/s
Measured over 12month periods
Cash is worth only what it can purchase = less if inflation and more in deflation
Currency movements impact price of g/s and inflation rate
Controls of inflation are interest rates and money supply
How is inflation measured
Consumer price indices (CPI)
- price of average basket of goods
- monthly indicator of rate of inflation or deflation by recording changes in price paid for goods/ services
Retail Price Index
-general measure if inflation used as basis indexation of pensions, state benefits and index linked bonds
Retail sales index (RSI)
- records purchasing trends = consumer confidence
- measures monthly movement in average turnover of retailers in UK over 4/5 week period
- doesn’t include goods sold on internet/ goods supplied over seas through internet so accurate recording difficult
Public Sector Net Cash Requirement (PSNCR)
- public sector net cash requirement
- how much gov needs to borrow to cover liabilities from what it can’t collect from tax (gap between gov spending and tax receipts)
High PSNCR and national debt due to 2007 credit crisis
Methods of controlling inflation
Money supply
total amount of cash in circulation, bank deposits and best money savings
Influences; price levels, inflation, business cycle
Controlling money supply important control of economy (all money used in economic transactions)
What does increase in money supply cause
- lower interest rates
- increase economic activity/ increase in spending
- rise stock markets
- increase consumer confidence
- expansion of economy
- inflation
- rise in prices of g/s
Definitions of money supply
MO - UK cash outside BOE and banks operational deposits with BOE
M1 - narrow measure of money (cash and deposits)
M2 - broader measure incl savings
M3 - even broader measure incl items substitute money
M4 - cash outside banks + private sector retail bank + private sector wholesale bank and building society deposits and CDs
Methods of controlling inflation
Interest rates
Higher interest rates make more expensive to borrow & lower rates encourage borrowing
Therefore indirectly control economy/ takes several months for desired impact
Base Rate - interest rate set by Monetary Policy committee of BOE
If economy enters inflation period due to increased demand as money cheap and easy to borrow, rising interest rates reduce demand through cost of borrowing and making saving money on interest bearing banks attractive
If economy entered recession reducing interest rates could stimulate demand in order to correct movement
What is qualitative easing
QE is an instrument used by central banks to bring down IT rates for co’s/ households by creating money in economy
Makes cash available to stimulate economy and prevent entering deflationary period
Purchasing assets form commercial banks and paying for purchase by increasing balance of funds available in accounts held with central banks
Commercial banks in position to lend money to private consumers who should spend it in economy (multiplier effect to start recovery)
Positives of QE
- extra money should boost spending/ encourage spending
- unlike it rates there’s no limit amount central banks can provide but chance of inflation monitored
- shorten recession / prevent deflation
- lower interest rates
Negatives of OE
- could lead to inflation
- less understood as it rates changes/ harm confidence
- assets could lose value and central bank loses money (covered by taxpayer)
- cash provided could be saved not spent
- central banks can be difficult to work with
- difficult to know how much QE required
Main risks of QE
Hyperinflation
-rapid inflation leads to complete loss of confidence in sustainable purchasing power of a country’s currency, could result in economic collapse
Germany between WW1 and WW2
Japanese has no effect 2001 for 4 Years
Assists stock markets in UK 2009
