Inflation

Inflation Rate Price Indexes Demand-Pull Inflation Cost-Push Inflation Upward Spiral of Prices and Wages Impacts of Inflation

Inflation

Inflation denotes a rise in the general level of prices. The overall price level is measured by price indexes.

Deflation and Disinflation

Deflation occurs when the general level of prices is falling. Deflation have been rare in the late twentieth century. Disinflation denotes a decline in the rate of inflation.

Price Index

A price index is a weighted average of the prices of a number of goods and services. Each price is weighted according to the economic importance of the commodity in question.

Price Index

CPI Consumer Price Index measures the cost of a market basket of consumer goods and services, including prices of separate classes of commodities. PPI Producer Price Index measures the level of prices at the wholesale or producer stage. GDP Deflator (IPD implicit price deflator) is the ratio of nominal GDP to real GDP and can thus be interpreted as the price index of all components of GDP.

Price Index

CLI Cost of Living Index measures the cost of a market basket maintaining a certain standard of living. The Price Index of Agricultural producers is calculated from prices collected among selected producers in agriculture (private, cooperative and state-owned companies) and does not include VAT. Import and Export Price Indexes measure average changes in prices of goods and services that are imported or exported.

Inflation Rate

Inflation rate () is the rate of change of general price level measured e.g. by CPI:

CPI t CPI t 1 t 100 CPI t 1

t = given year

Three Categories of Inflation

Moderate Inflation is characterized by slowly rising prices (single-digit annual inflation rate). Galloping Inflation: inflation in the double- or triple-digit range. Hyperinflation occurs when prices rise at a thousands, million or trillion percent annually.

Inflation

From the visibility point of view:

Open Inflation Hidden Inflation Stifled Inflation

Inertial Inflation

Inertial Inflation is the rate of inflation that is expected and built into contracts and informal arrangements. This built-in inertial inflation rate tends to persist until a shock causes it to move up or down.

Demand Pull Inflation

Demand-pull inflation occurs when AD rises more rapidly than the economys productive potential. Demand-pull inflation can arise from:

High supply of money Excessive fiscal deficits

Demand Pull Inflation

AS P

With a steep AS curve, much of the higher aggregate spending ends up in higher prices.
E1
E AD1 AD QP Q1 Q

P1

Cost Push Inflation

Cost-push inflation is resulting from rising costs during periods of high unemployment. Cost-push inflation is a new phenomenon of modern industrial economies.

Cost Push Inflation

AS1 P AS

P1 P

E1 E AD Q1 QP

Cost-push pressures dominate when labour unions exercise market power by rising wages, or when external factors drive up prices of raw materials unexpectedly.

Upward Spiral of Prices and Wages

An upward spiral of prices and wages occurs when aggregate supply and demand shift up together. When prices and wages are rising and are expected to continue doing so, businesses and workers tend to build the rate of inflation into their price and wage decisions.

Upward Spiral of Prices and Wages AS

2

AS1 AS

E2 E1

Inertial inflation occurs when the AS and AD curves are moving steadily upward at the same rate.
AD2

AD1 AD QP Q

Slumpflation
AS1 P AS

P2
P1 P

E1 E

As long as inertial elements driving up costs are powerful, a recession may occur simultaneously with high inflation.
AD

Q1 QP

Effects of Inflation

Microeconomic effects of inflation on income and wealth distribution

Consumers and investors change their habits (redistribution of expenditures) Income redistribution - people with fixed income are less able to cope with inflation Wealth redistribution in general, those who have borrowed money are better off and it hurts those who have lent money.

Effects of Inflation

Macroeconomic effects of inflation

Consumption structure changes, investment decisions became more complicated total output falls Substitution of labour for capital (if wages are growing faster than productivity) structural unemployment increases Exchange rate fluctuation , export is more expensive, domestic currency depreciates prices of imported goods are growing . Final effect of depreciations depends on price elasticity of imported and exported goods.

Effects on output and economic efficiency - inflation may be associated with either a higher or lower level of output and employment; There is no effect on real output, efficiency, or income distribution of an inflation that is both balanced and anticipated.

Anti-Inlationary Policy

Fiscal policy, monetary policy and supplyside policy. Government and Central bank antiinflationary measures:

Decrease of budget deficit Loan restriction Price and wage freeze