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Flashcards in Price Stability Deck (15)
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1

What is the aim of price stability?

Maintaining a low but positive inflation rate over time

2

What is inflation

Refers to an increase in the GPL of g&s in an economy

3

What is deflation

Refers to a decrease in the GPL of g&s. Occurs when the inflation rate FALLS BELOW 0

4

What is disinflation

Refers to a decrease in the RATE of inflation, a slowdown in the rate of incr of the GPL of g&s

5

What is stagflation

Refers to the situation of high unemployment and rapid inflation with depressed level of output
e.g. in the 70s and 80s due to the oil crises

6

What does the Consumer Price Index (CPI) do?

- most common indicator used by govs to measure changes in the GPL
- it measures the change in the px of a fixed basket of cr g&s commonly purchased by the average hh in an economy in a specific year.

7

Limitations of CPI

- may not be representative of all hhs as the fixed basket of g&s may not be representative of every single hh's consumption patterns. consumption patterns may differ.
- CPI figures do not sufficiently track changes in consumption pattern as the basket of g&s used in CPI computation is updated only periodically. the basket may not be reflective of the typical g&s purchased by hhs over time
- changes in CPI do not take into account changes in the quality of g&s consumed. if quality improves, cost of living falls and the converse is true too.

8

What is "internal value of money"?

internal value of money is defined as the amount of real g&s that it can buy, i.e. the purchasing power of a given sum of money.
GPL incr --> purchasing pwr decreases
GPL decr --> purchasing pwr increases

*note: external value of money depends on exchange rate

9

what is demand-pull inflation?

occurs when AD is rising near or at the full employment level, causing upward pressure on prices

10

causes of dd-pull inflation?

G
- expansionary FP
- expansionary MP

E
- expectations of rising Ys or GPL

E
- relative inflation rates
- depreciation of dom currency
- changes in T&P of foreign crs (increases X)
- high ec growth rates of TPs

11

what is cost-push inflation?

caused by continuous increase in unit COP, for reasons not associated with incr in AD

12

causes of c-p inflation?

- imported inflation (caused by mkt conditions - dd&ss factors; depreciation of dom currency)
- negative supply shock
- wage-push inflation
- tax-push inflation
- profit-push inflation (firms exercise their mkt pwr, restricting o/p to raise pxs in order to maximise their own profits)

13

consequences of unexpected high inflation

macro effects
- INTERNAL EFFECTS: undermines LR EG & future SOL
---> erodes business confidence, I falls
---> since savings by hhs fall in real terms -> pp falls with the same sum of money -> discourages hhs savings -> hhs will choose to buy other gds that serve as stores of wealth e.g gold -> less funds available for firms' investment as savings decline -> I falls (recall that real i/r = nominal i/r - inflation rate)

- EXTERNAL EFFECTS: incr in relative inflation undermines ec competitiveness and ext stability
---> X becomes less px competitive in world mkts -> assuming dd for cty's X to be px elastic, there will be a MTP fall in Qd of X -> fall in X rev. PLUS px of M fall dd for M incr as dom crs switch from dom gds to M -> incr in M exp THEREFORE next X falls, worsen current acc balance, worsen BOP
---> decr in foreign investment & LT capital inflow: rapid incr in uCOP might reduce the expected RoR on investment in the cty and deter new foreign investors and existing investors may relocate
---> ST capital outflow (hot $ outflow): high inflation rates may lead to capital flight as speculators, anticipating a fall in exrs, sell currency A for currency B where the monetary situation is more stable, to avoid exchange losses

microec effects
- allocative inefficiency (sends inaccurate price signals in the market, leading to under or over-production of some g&s)
- arbitrary redistribution of Y
- firms may gain at the expense of crs

14

causes of deflation

decr in AD, bad
- comes with falling RNY and rising unN

incr in AS, good
- SR: lowered uCOP, possibly due to removal of min. wage legislation/ fall in px of key raw materials
- LR: lowered uCOP due to incr in Q&Q of resources, e.g. incr in L pdtivity due to investment in human capital/adoption of new tech/incr in size of L force

15

consequences of deflation

macro effects
- INTERNAL EFFECTS:
---> in periods of falling AD, ability of pxs to adjust downwards helps to moderate the contraction of the ecy
---> SR: fall in C & I cause deflationary spiral; LR: fall in I means a lower rate of capital accumulation, limits the rate at which the ecy's pdtive capacity can expand in the LT
---> in periods of deflation, exp MP through i/r cuts could be rendered ineffective

- EXTERNAL EFFECTS:
---> improve BOT
---> deflation -> crs postpone consumption -> limited firms ability to incr pxs of final g&s -> expected RORI w/n the cty falls -> incr outflow & decr inflow of LT capital
---> dom currency appreciates