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To what extent may it be argued that Inflation is preferable to

Deflation?
Inflation is the general rate at which the level of prices for goods
and services is rising, and as a result purchasing power is falling. In
the UK, low amounts of inflation are seen as a positive thing
(providing stability) and the Bank of England has a symmetrical
target of 2% for inflation (give or take a 1%.) This is the case with
central banks of many developed countries. However, high,
fluctuating rates of inflation historically have not been a positive
thing. An example would be the hyperinflation of Germany because
of debt accumulated during the WW1. On the opposite end of the
spectrum, is the general decrease in prices- often caused by a
decrease in the money supply. This occurred in Britain during the
1930s amid the Great Depression where it was at 2-5%. The
question of whether or not inflation is preferred to deflation is
ultimately about which option offers relative price stability. However,
the type of inflation or deflation that occurs is also significant, the
long and short term costs and benefits, whether or not the economy
is in a boom or recession and the various policies that would have to
be implemented in order to control inflation or deflation.
Inflation, which is generally preferred by developed economies (at
a low level) comes in two types (according to Keynesian economists)
and that is Demand Push and Cost Push. Demand push inflation is
caused by excessive aggregate demand for a certain output. In

other words, excess demand.


The graph above visually displays demand pull inflation. Aggregate
demand and supply are initially represented by the AD1 curve and
the SRAS, and macroeconomic equilibrium is at point X. Real
national output is Y1 and the price level is P1. There is also spare
capacity within the economy, which shows that demand deficient
unemployment is also present. If aggregate demand were to

increase to AD2, real output and price level would both also increase
to YFE ad P2. Hence, demand deficient unemployment is eliminated,
but this results in some inflation. Once full employment arrives, real
output cannot increase anymore in the short run, as the economy is
now producing at its production on the SRAS curve and an increase
in AD would only lead to inflation, with no output increase. This
however is only short term. Possibly, in the long term, there would
be an outward shift in the PPF boundary of the
economy, which displayed on the right as a shift
from A to B.
Thus, in the long term, demand pull inflation
would be positive is at would lead to increased,
sustainable economic growth as well as an
increase in employment, both of which are
macroeconomic objectives for the economy.
However, it is questionable as to whether or not
this growth and increase in employment is
sustainable. Keynesian economists would argue it
is, as this benefits were created by injecting
money into the economy. If it was a relatively low level of inflation
after the increase to AD2 (first graph) then the growth and
employment would be sustainable. Hence, demand-pull inflation is
in the long term, a positive thing. Although economists would not
call this sort of inflation good inflation because there are still costs
of demand pull inflation. Instead it is considered normal inflation.
Another positive aspect of demand pull inflation, aside from higher
employment and increased economic growth is that it is relatively
easy to control, compared to its counterpart cost push inflation. For
example, if the MPC felt that the economy was growing too strongly
and demand pull inflation was increasing too quickly, they could put
up interest rates to lower the interest rates. There could however be
time lags and it would be difficult to decide when to raise the
interest rates exactly, but policy makers are used to this sort of
inflation and how to get it down or up to their desired target.
However, again this idea of controllable inflation is only applicable
to times of good sustainable economic growth. An example would
be the economy circa 2013. Inflation was well above target but
interest rates could not be raised because the economy was in a
recession and thus unemployment was very low.
Cost push inflation, which is considered by economists as the
wrong sort of inflation is caused by rising costs of production.

The diagram above displays cost push inflation. Initially,


macroeconomic equilibrium is at point X, with real output and the
price level respectively at Y1 and P1. A firms money costs of
production rise, say because of increased raw material costs. This
would cause the SRAS curve to move upward and to the left. From
SRAS1 to SRAS2. The cost-push inflationary process increases the
price level to P2, but higher production costs have reduced the
equilibrium level of output that firms are willing to produce to Y2. A

new macroeconomic is now at Z. Increased cost push inflation could


lead to, in the short term lower GDP growth, falling living standards,
rising energy prices, higher taxes. However some economists have
argued that cost push inflation will lead to long term inflation
because consumers will see the increase and in prices and fall in
real wages. This could lead to people arguing for increased wages,
which would lead to increased sustained inflation or they would cut
spending. The fall in living standards- caused by cost push inflation
is something that the UK has witnessed since 2008- as a result in
the fall of wages. The country has dealt with increasing prices and
falling incomes. Thus, it would be argued that demand pull inflation,
at a reasonable and sustainable rate, in a time of economic boom
would be preferable to cost push inflation.
All economists would agree that inflation can have adverse costs.
However, the serious of these effects depends upon whether or not
the inflation is anticipated or not. If inflation could be anticipated
with complete certainty, it would pose very little problems as
households and firms would just build the expected inflation rate
into their economic decisions- adjusting. If inflation is low, with little
variation year to year it is relatively easy to predict next years
inflation rate. This sort of inflation, called creeping inflation is
associated with expanding markets, healthy profits and general
business optimism is known to stimulate the economy. From this
angle, it could be argued that a low rate inflation (without absolute
price stability) may be a side effect to expansionary policies
(investment etc) to reduce unemployment.
Also, low, stable rates of inflation may also be necessary to allow
labour markets to function efficiently. Even if real wage rates are
rising, there will be some labour markets in which real wages must
fall in order to maintain relatively low rates of unemployment. To
save their jobs, workers may be willing to accept falling real wages
caused by nominal wage rates rising at a slower rate than inflation.
However, workers would be less willing to accept absolute cuts in
nominal wages. Hence, with no inflation, the changes required in
real wage rates to make labour markets function efficiently does not
take place. Labour markets function best when is inflation is existent
but low, as well as being stable. To contrast this, absolute price
stability causes wage stickiness which would result in
unnecessarily high unemployment. Thus, low and stable inflation is
desired to keep unemployment low and help sustain economic
growth.
However, when inflation becomes difficult to anticipate. One
negative impact of inflation is its distributional effects. Weaker social
groups, such as pensioners on fixed incomes lose whilst others in
strong bargaining positions gain. Another negative effect of inflation
is that it leads to international uncompetitiveness. When the
inflation rate is higher than in competitor countries, exports increase
in price, making them uncompetitive. However, the long term

benefits of reduced unemployment, increased investment and this


economic growth do outweigh the consequences listed above.
Deflation, which is on the other end of the spectrum to inflation is
the general decrease in the price level. In the late 1990s and early
2000s, the UK inflation rate fell towards 1% and some economists
argued that deflation would soon occur. This fear occurred again in
2008 following the recession. Predicted deflation (without actually
occurring) already causes its own problems. If consumers believe
that prices will fall, they will resist spending on expensive items- out
of hopes for a decrease in price. This could erode business
confidence and trigger recession or deepen and lengthen a preexisting recession. This is considered bad deflation.

Bad deflation is caused by a collapse in aggregate demand


(displayed by the shift from AD1 to AD2,) negative multiplier effect
and quite possibly a credit crunch. Bad deflation generally occurs
when people are uncertain about the future
Good deflation

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