Inflation Flashcards

Question

what policies could be used to bring down demand pull inflation

Answer 1

- contractionary demand side policies(monetary or fiscal), eg a cut in govt spending or an increase in tax

Answer 2

🏦 1. Monetary Policy May Hurt Growth (Interest Rate Increases) Raising interest rates → Reduces consumption & investment → Slower economic growth If growth falls too much → Could cause higher unemployment Especially problematic if inflation is cost-push (e.g. oil shock) → Interest rates don’t tackle the root cause Monetary policy may control inflation, but at the cost of rising spare capacity and social hardship 📉 2. The Phillips Curve Trade-Off To reduce inflation → Government/central bank applies contractionary policy → Unemployment rises Shown by movement along the short-run Phillips Curve → Lower inflation comes with higher unemployment This can be politically unpopular & economically damaging → Especially if workers lose bargaining power In long run, expectations may adjust → Curve becomes vertical → Reduces the effectiveness of this trade-off 📊 3. Fiscal Policy Takes Time & May Worsen Deficit Using contractionary fiscal policy (higher taxes/lower gov spending) → Reduces AD → Inflationary pressure falls However, takes time to implement due to political delays May reduce public services & welfare spending → Hurts long-term development Also risks worsening budget deficit if tax revenues fall due to slower growth 🔁 4. Supply-Side Policies Take Time to Work Policies to increase productivity (e.g. investment in skills, deregulation) → Increase AS → Reduces inflationary pressure However, these policies work in the long run, not useful for current inflation Costly to implement and may not guarantee results Risk of worsening inequality or reducing workers’ protections if deregulation is overused

Answer 3

the monetary policy transmission mechanism has got a variety of avenues where interest rates changes can feed through into the economy

Answer 4

savings that chase the interest rate, eg if interest rates are relatively high in one country, savers from one country will move their money to that country, increasing the demand of the currency in the country they moved the money to Hot money inflows enter the country → Increase in foreign reserves & financial capital in domestic banks. Banks have more funds to lend . Increases access to investment finance for firms ⬇️ Higher investment leads to capital accumulation .Boosts the capital-output ratio (more machines, factories, etc.) .Increases productive capacity of the economy, Higher economic growth With sustained growth → Higher incomes → More savings in the economy ,Feeds back into the Harrod-Domar cycle (growth depends on savings and capital efficiency) , leads to long-term development outcomes improve (jobs, infrastructure, tax revenue)

Answer 5

🏭 1. Subsidies to Firms ➡️ Government provides subsidies to firms facing high costs ➡️ Helps lower production costs (e.g. for raw materials or energy) ➡️ Firms can maintain or reduce prices despite higher input costs ➡️ Leads to a reduction in cost-push inflationary pressures 📉 2. Reducing Indirect Taxes (e.g. VAT) ➡️ Cutting indirect taxes reduces final prices of goods/services ➡️ Lowers the price level directly, especially for essentials ➡️ Improves real disposable income and maintains purchasing power ➡️ Helps control inflation driven by tax-induced cost increases ⚡ 3. Improving Supply-Side Efficiency ➡️ Investment in productivity and technology reduces unit costs ➡️ Firms become more competitive and absorb higher input costs ➡️ Less need to pass on costs to consumers via higher prices ➡️ Mitigates cost-push inflation in the long run 🔓 4. Deregulation ➡️ Removing excessive red tape lowers compliance and operating costs ➡️ Especially in sectors like energy, transport, and telecoms ➡️ Can lead to lower prices and less inflationary pressure ➡️ Encourages more firms to enter and compete on price 🌍 5. Exchange Rate Appreciation ➡️ Stronger domestic currency makes imports cheaper ➡️ Reduces costs of imported raw materials and goods ➡️ Helps firms cut costs and keeps consumer prices low ➡️ Can reduce imported cost-push inflation

Answer 6

- increasing subsidies or cutting VAT has a significant government cost and may worsen govt finances - intervention in forex not very smart as many countries have free floating exchange rates - cost push inflation is usually short term, eg costs of raw materials dont usually stay high for a long time, don’t need to worry abt them as much - can’t really do anything abt them, so shouldn’t really worry

Answer 7

🏦 1. Contractionary Monetary Policy The central bank increases interest rates → cost of borrowing rises and reward for saving increases → consumption and investment fall → aggregate demand (AD) decreases → inflationary pressure falls 💼 2. Contractionary Fiscal Policy Government reduces spending or increases taxes → households and firms have less disposable income → consumption and investment fall → AD falls → reducing demand-pull inflation 📈 3. Supply-Side Policies Government invests in infrastructure or education to improve productivity → long-run aggregate supply (LRAS) shifts right → greater capacity in the economy absorbs demand without increasing prices → inflationary pressures ease in the long term ⏳ 💷 4. Exchange Rate Appreciation (if using a managed or fixed rate) Central bank increases interest rates to attract hot money → currency appreciates → import prices fall → imported cost-push inflation decreases → stronger currency also dampens export demand → lower AD 🏭 5. Price and Income Policies (less commonly used) Wage and price controls are imposed → firms are restricted from raising prices or wages → temporary freeze in inflationary expectations → but risk of shortages or reduced investment -

Answer 8

1). no guarantee of success 2) costs - risk of wasteful spending/high oppurtunity cost 3) negative stakeholder impact 4) time lags - depends on type of inflation - rate of inflation, if inflation is around 2% we dont need to do anything

Answer 9

the average of the current prices of goods and services in the economy

Answer 10

- households take the household expenditure survey - A representative basket of goods and services used by average households is recorded - Items are weighted according to proportion of spending on each product - inflation rate measures change in average prices in an economy over a year

Answer 11

- A weaker pound makes imports more expensive since it takes more pounds to purchase the same amount of foreign currency. This increases the cost of imported goods and raw materials - A weaker pound makes exports cheaper for foreign buyers, leading to increased demand for British goods and services abroad. This rise in demand can put pressure on domestic production capacity, leading to increased prices.

Answer 12

- interest rates usually increase when theres high inflation to incentivise saving - as interest rates rise,debt holders repayments increase - leaves them w lower disposable income

Answer 13

- As consumers delay spending, overall demand for goods and services falls. - With reduced consumption, businesses experience lower sales and profits, leading to cuts in production, wages, and employment(derived demand). Investment spending also declines, as firms hold back on expanding in a low-demand environment - Lower consumption and investment reduce AD, potentially triggering further deflation and economic stagnation, as businesses face ongoing demand-side pressure. - Central bank cuts interest rates to stimulate economy → But if inflation is negative, real interest rates may still be high → Monetary policy becomes ineffective → Economy remains stuck in low growth

Answer 14

🕒 Delayed Consumption → Deflation leads to falling prices → Consumers expect goods to be cheaper in the future → They delay spending and consumption today → This reduces aggregate demand, worsening the slowdown 📉 Lower Aggregate Demand (AD) → Falling prices reduce consumer and business confidence → Consumers cut back on spending; firms delay investment → Aggregate demand falls, causing slower economic growth → This can increase cyclical unemployment 🏭 Lower Supply Orders → Businesses anticipate weaker demand due to deflation → They reduce production and scale back on supply chain orders → This impacts suppliers and upstream firms → Negative multiplier effects ripple through the economy 💸 Higher Real Value of Debt → Deflation increases the real (inflation-adjusted) value of debt → Households and firms struggle more with repayments → Consumption and investment fall as income is diverted to debt servicing → Risk of defaults increases, stressing the financial system 🏚️ Lower Value of Fixed Assets → As general price levels fall, asset values (e.g., houses, factories) also fall → Firms and individuals see a fall in their wealth → This leads to a negative wealth effect, reducing confidence and spending further → Could also trigger balance sheet issues for businesses 📉 Less Investment → Falling prices reduce firms’ expected future revenues and profits → This discourages capital investment → Productivity growth stalls, damaging long-term economic potential → Could lead to a deflationary spiral if confidence collapses further

Answer 15

💸 1. Fall in Real Incomes If nominal wages don’t rise as fast as inflation → Real purchasing power of consumers declines → Households can afford fewer goods and services → Reduction in living standards, especially for low-income families 🛍️ 2. Menu Costs and Price Confusion Firms frequently change prices to keep up with inflation → Consumers face price uncertainty and lose track of value → Makes it harder to make informed spending choices → May reduce consumption and economic confidence 💳 3. Regressive Impact on the Poor Inflation often hits essential goods (food, fuel) hardest → Poorer households spend a larger share of income on necessities → Inflation disproportionately affects their wellbeing → Worsens income inequality 🧠 4. Lower Confidence and Future Planning High or unpredictable inflation → Consumers find it harder to budget or plan savings → May save more out of caution and reduce current spending → Lower consumer confidence → Fall in aggregate demand

Answer 16

📉 1. Increased Uncertainty and Reduced Investment High or volatile inflation → Firms can’t predict future costs or revenues accurately → Increases business uncertainty → Reduces willingness to invest in long-term projects → Slows down capital formation and productivity growth 💸 2. Rising Input Costs Inflation increases prices of raw materials, energy, and wages → Firms face higher production costs → Profit margins shrink if they can’t pass costs onto consumers → May lead to layoffs or reduced output 🏷️ 3. Menu Costs Firms must frequently change prices to keep up with inflation → Involves costs like reprinting menus, labels, updating websites → These admin costs reduce profit → Particularly burdensome for small businesses 🌍 4. Loss of International Competitiveness Domestic inflation rises faster than trading partners’ → Export prices become relatively more expensive → Demand for exports may fall → Firms lose market share abroad → Negative impact on trade balance and output

Answer 17

💰 1. Fiscal Drag (Bracket Creep) Inflation pushes nominal incomes into higher tax brackets → People pay more income tax despite no real income gain → Increases government tax revenues → But may reduce incentives to work/spend 🧾 2. Increased Welfare Spending Inflation raises cost of living → More pressure to increase welfare payments like pensions, Universal Credit → Increases government expenditure → Worsens budget deficit if tax revenues don’t rise equally 💵 3. Reduced Real Value of Government Debt Inflation erodes the real value of outstanding government bonds → Easier for government to pay off past borrowing → Good for managing high national debt → But only if interest rates remain low 📉 4. Pressure on Monetary Policy & Credibility Persistent inflation → Government may face political pressure to respond (e.g. support BoE tightening policy) → Can reduce public trust in government’s ability to manage the economy → Political instability may rise

Answer 18

💼 1. Unemployment increases Firms reduce prices to stay competitive → lower profit margins → some firms may reduce output or close down → leading to higher unemployment, especially in sectors where demand is price elastic 💸 2. Falling wages → Reduced consumer spending Wage restraint or cuts (due to lower inflation expectations) → lower disposable income for workers → reduced consumption demand → leads to lower overall economic activity and less inflationary pressure Impact on businesses’ profitability Supply-side deflation could lead to a "race to the bottom" → firms cut prices in a competitive environment → may harm long-term profitability → especially for firms that cannot lower costs as effectively, reducing their sustainability

Answer 19

Demand-side causes of deflation 💰 1. Decrease in aggregate demand Falling consumer confidence → reduced household spending → lower overall demand for goods and services → leads to downward pressure on prices as firms struggle to sell their goods 📉 2. Contractionary fiscal policy Government reduces public spending or increases taxes → disposable income falls → consumption and investment decrease → aggregate demand drops, resulting in lower price levels 🏦 3. Increase in interest rates Central bank raises interest rates → cost of borrowing rises → consumers and businesses borrow less → reduces spending and investment → aggregate demand falls, contributing to deflation 🏚 4. Rise in unemployment Higher unemployment rates → reduced household income → consumers cut back on spending → lower demand for goods and services → firms reduce prices to stimulate demand, causing deflation 📊 5. Global economic slowdown Weak economic conditions globally → reduced demand for exports → lower overall demand in the domestic economy → contributes to deflation as businesses lower prices to maintain competitiveness **Supply-side causes of deflation** 🔧 1. Technological advancements Improvements in technology → productivity increases → firms can produce more with fewer resources → drives down production costs → businesses lower prices, contributing to deflation 🏗 2. Falling production costs Decrease in the price of raw materials or energy → firms’ input costs fall → they can produce goods more cheaply → firms may lower their prices, causing deflation 💼 3. Increased competition Deregulation or entry of foreign firms into the market → more firms competing for market share → firms lower their prices to attract customers → leads to deflationary pressure in the market 🛠 4. Wage restraint or cuts Government or firms enforce wage cuts or restrain wage growth → reduces costs for businesses → firms may pass on these savings to consumers through lower prices → causing deflation 💸 5. Strong currency Currency appreciation (e.g., due to high foreign investment or interest rate policies) → reduces the cost of imports → cheaper imported goods put downward pressure on domestic prices → contributing to deflation

Inflation Flashcards

(44 cards)