Costs and Benefits of Inflation Flashcards
(26 cards)
What is the macroeconomic objective for inflation?
Low and stable inflation — typically around 2% (e.g. Bank of England target).
What is a major cost of inflation on consumers?
Lower real purchasing power — if wages don’t rise with inflation, people can afford fewer goods/services, reducing living standards and possibly increasing poverty.
How does inflation affect savers?
Erosion of savings — if interest rates on savings are lower than inflation, real value of savings falls.
Also leads to shoe leather costs as people spend time searching for better rates.
How does inflation affect exports?
High inflation makes domestic goods more expensive relative to foreign goods, reducing export competitiveness and worsening the current account.
What is a wage-price spiral?
When workers demand higher wages to keep up with inflation, leading firms to raise prices, causing further inflation — a self-reinforcing cycle.
What are menu costs?
The administrative costs to businesses of constantly updating prices due to inflation (e.g., reprinting menus, changing barcodes, reprogramming tills).
What is an inflation spiral?
When rising wages and prices continuously feed into each other, creating persistent inflation.
Starts with workers demanding higher wages → firms face higher costs → raise prices → cycle repeats.
What is inflationary consumption?
When people expect prices to rise, they bring forward spending to avoid higher future prices. This increases AD, leading to demand-pull inflation.
What is hyperinflation?
Extremely high and accelerating inflation, where money rapidly loses value. It can destroy confidence in an economy and collapse financial systems.
What is inflationary noise?
When inflation is volatile, it becomes difficult for firms and consumers to distinguish real price changes from general inflation, leading to inefficient decisions.
What is fiscal drag?
When inflation pushes nominal wages into higher tax brackets under a progressive tax system, increasing tax liability without an increase in real income.
How does inflation reduce the effectiveness of price signals?
With high inflation, it’s harder to tell if price changes are due to supply/demand shifts or general inflation — distorts price signals, reducing allocative efficiency.
How does inflation create uncertainty for long-term investment?
High or unpredictable inflation increases uncertainty about future costs and revenues, discouraging investment and long-term economic growth.
What’s a benefit of moderate inflation for workers?
Workers can negotiate higher wages, improving living standards if wage growth exceeds inflation.
Why is moderate inflation good for consumption?
It supports natural, stable consumption — people aren’t rushing to spend like during inflation spikes or postponing like in deflation.
How can inflation encourage firms to increase output?
With moderate inflation, firms can raise prices and increase revenues, giving them an incentive to expand production.
How does inflation help firms avoid layoffs during a recession?
Firms can raise prices (e.g., 5%) and give only a small wage increase (e.g., 1%), keeping costs down while avoiding job cuts, preserving employment and skills.
How does moderate inflation help firms retain workers in a recession?
Firms can raise prices without large wage increases, allowing them to keep productive workers while controlling costs.
How can inflation support workers during a recession?
Workers keep their jobs and receive modest wage increases, avoiding unemployment during downturns.
How can inflation help reduce the real burden of debt?
Rising prices (and wages) erode the real value of debt, making it easier for firms, households, and governments to repay.
Why do governments benefit from moderate inflation (fiscal perspective)?
They gain from fiscal drag and rising VAT/corporation tax revenues, improving public finances.
How does the rate of inflation affect whether it’s good or bad?
Low and stable inflation → more benefits than costs.
High inflation → more costs than benefits due to risks like spirals and uncertainty.
Why is the cause of inflation important when evaluating it?
Demand-pull inflation → linked to growth, easier to manage.
Cost-push inflation → leads to stagflation (low growth + high prices), harder to solve.
What risks are associated with long-term high inflation?
It can lead to inflation spirals and eventually hyperinflation, severely damaging the economy.
