Low/Stable Inflation Flashcards
Inflation
Persistant, sustained increase in the average price level in an economy (>3%)
Negatives of high inflation (5)
Loss of purchasing power, impact on saving, impact on economic growth, impact on interest rates, impact on exports, impact on labour markets
Impact of high inflation on economic growth
People choose to spend money instead of save, banks have less money to lend to producers, less ‘I’ so AD decr and GDP decr
What does inflation do to the interest rates?
Interest rates increase as banks need to lend money to consumers at a higher rate than the inflation to ensure their return is positive
What does inflation do to exports?
Domestic inflation means goods are more expensive so exports are less competitive in international market.
CPI
Consumer price index, measures the price change on a basket of consumer goods. Uses a weighted index to reflect importance of the goods.
Issues with measuring inflation (5)
Doesn’t reflect all consumers, consumption habits change, cannot compare countries as different goods, errors in collection and sudden changes
How can inflation be measured more accurately?
Core/underlying inflation rate is calculated without groups of products with volatile price changes
PPI
Producer price index - measures prices of goods/services used by producers
XPI
Export price index - index of prices of exported goods and services
MPI
Import price index - index of imported goods and services
Two types of inflation
Demand pull and cost push
Demand pull inflation
Caused by an increase in AD due to changes in C, G, I, X, M
Cost push inflation
Caused by the increase in costs of production, SRAS shifts left
How to reduce demand pull inflation?
Contractionary fiscal and monetary policies which reduce aggregate demand
How to reduce cost push inflation?
Govt has little control due to increasing costs of production so must also use contractionary fiscal and monetary policies to reduce AD
What are the problems with using contractionary fiscal and monetary policies to reduce inflation?
Not very popular with govt, takes time to implement, AD decreases so employment levels and real GDP fall, trade off between economic objectives
Deflation
A persistant fall in the average level of prices
Good deflation
Improvement in supply side of the economy, SRAS shifts
Bad deflation
When PL decreases due to a decrease in AD (AD shift)
Disinflation
When the price level is increasing but at a diminishing rate
Cost of bad deflation to the economy
Unemployment increases, consumers defer consumption, reduced consumer confidence, reduced business confidence and investment
Rate of inflation calculation
(New CPI - Old CPI)/(Old CPI) x 100
Formula for weighted price index
Formula = average price of good A x spending weighting + (… of B)
