INFLATION & DEFLATION Flashcards
(18 cards)
What is inflation?
A sustained increase in the general price level
What is disinflation?
When price inflation slows temporarily
What is deflation?
A sustained decrease in the general price level
What is the Fisher equation?
Nominal inflation rate = Real interest rate/Inflation
When is the fisher equation used?
When investors or lenders ask for additional reward to compensate for losses in purchasing power due to inflation
What does the Quantity theory of money state?
The general price level of goods/services is proportional to the money supply in an economy
What is the formula for the Quantity theory of money?
Money supply x Velocity of money = Price level x real GDP
What are some criticisms of the Quantity theory of money?
- Neglects role if I.R as causative factor between money and prices.
- Money velocity isn’t stable and in the SR prices are sticky so direct relationship between money supply and PL doesn’t hold.
What is Demand pull inflation?
When an increase in AD puts pressure on AS, creating upwards pressure on prices.
What are 6 consequences of inflation?
- Decreased real Y
- Decreased I
- High costs to reduced inflation
- Less competitiveness
- Decreased real value of savings
- Menu costs
What is Cost push inflation?
When increased CoP lead to a decrease in AS and thus and increase in the general price level.
What are Demand side policies to reduce inflation?
Contractionary fiscal policy
- Increased T
- Decreased G
Contractionary monetary policy
- Increased I.R
- Decreased money supply
What are some supply side policies and what is their aim?
- Privatisation
- Deregulation
Aim: to increase LR competitiveness by reducing firms’ CoP to reduce the general price level and thus reduce inflation.
What is malign deflation?
(Bad) Deflation connected to weak D that causes a downwards spiral in prices.
( Falling AD)
What is benign deflation?
(Good) Deflation associated with an increase in productivity, often from technological advances, which drives down prices.
What are 3 consequences of deflation?
- Increased U - firms’ profits decrease so they have to let go of workers.
- Decreased C - consumers delay C as they wait for Ps to get lower → decrease in AD → Increased deflation.
- Increased real value of debt.
What policies can be used to reduce inflation?
Expansionary fiscal policy
- Decreased T
- Increased G
Expansionary monetary policy
- Decreased I.R
- Increased money supply
- Decreased E.R
Why might deflation be considered worse than inflation?
- I.R can’t be reduced below 0 so harder to stop than inflation
- Deflation → increased real burden of debt → discourages spending and I.
