Inflation

Inflation

" sustained general increase in price"
Measured:
1. CPI- measure of the price level used EU as BofE as int rates target. Lower than RPI.
2. RPI- traditional method, excludes mortgages and taxes
3. Aim to achieve price stability
4. Creeping- general steadily creep up few % on avg each year.
5. Prices of baskets of goods+services are recorded each month items are weighted with importance.
How accurate are indices used to measure:
1. Household spending patterns change overtime
2. Measures an avg rate for all households BUT in reality each household has different rates of inflation
3. Goods may increase in price but because of higher technical capacity
Hyperinflation:
1. Money becomes worthless
2. Huge amounts of cash printed to meet demand
3. Effect is always collapse in business confidence, recession, war and civil unrest
4. In most cases a new monetary system has to be created. EXAMPLE: 1920s Germany £20m Deutschmark was worth a match box. Russia prices ^ 36%of inflation.
Why have we kept inflation under control?
1. Technology reduced costs of production
2. More global competition so firms keeps prices low
3. Steady wage rates
4. Success of BofE in keeping AD under control by controlling int rates
5. 1990s-steady growth, unemployment falling steadily, cheap imports , no inflationary pay claims
Cure:
1. MONETARY- raise int rates to deflate AD but then output suffers
2. FISCAL- tax^ to reduced demand pull inflation
3. Offer tax free loans to ^ money supply to create jobs. E.g 20% tax free on a new house
Consequences
1. Money loses value- confidence and savings eroded
2. Cost push inflation
3. Disrupts business planning+ investment ( buy now or later )
4. FAVOURS- borrowers as inflation erodes value of existing debt. AD^ so inflation.
  1. BAD-pensions and savings eroded.
5. High prices so not as competitive= unemployment ^
6. High inflation so high interest to decrease AD
7. If inflation ^ in uk then the value of the £ doesn't change on foreign markets so exports less competitive
8. People feel less " well off" = bargain hunting
9. Opposite of wealth effect
10. Shops must adjust prices
Types and causes:
1. Demand-pull
  1. WHAT-Excess demand in +ve output gap. Businesses respond to high demand by price ^ . Supply cannot respond as quickly( in elastic SRAS)
    1. WHY- high levels of spending( tax down so income ^). Fast growth of demnd for credit +borrowing.fast growth in countries buying our exports.
      1. WHY- depreciation of UK £- price^ of imports and £dwn of exports
  2. Anlagen:
    - Untitled_1
2. MONETARIST
  1. MV=PT money supply x velocity of money= prices x transactions (GDP)
  2. Money travelling at speed over time raises prices- at the point when spending slows prices has gone up.
  3. ^ in money supply= fuel demand pull inflation.
3. COST-PUSH
  1. WHAT- increase in cost of production wages/imports , inelastic price rises eg gas, ^ in tax = prices ^ and demand for higher wages so inflation
  2. WHY- cost of production^ due to commodity price^ (external shock). Depreciation of UK £. ^ in wages.
  3. Firms raise prices to makre more profit margin as costs rise. Therefore prices^. Rising cost for business= gas, water, legislation,wages.
  4. INDEXATION- A way to anticipate inflation by raising public sector pay rises in line with inflation. people demanding the wages are causing the proble

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