Inflation and Anti-

inflation policy
Content

Inflation and its measuring

Types of inflation
Causes of inflation
Cost of inflation
Inflation and unemployment. The
Phillips curve
Anti-inflationary policy
 Dynamics of the Inflation Rate in the R.
Moldova
(1993 - 2014)

Year (%) Year (%)

1993 2705,7 2004 12,5
1994 104,6 2005 10,5
1995 23,8 2006 14
1997 11,2 2007 13,1
1998 18,3 2008 7,3
1999 43,3 2009 12,5
2000 18,4 2010 8,1
2002 4,4 2011 7,8
2003 15,7 2012 4,5

November, 29, 1993 the introduction of Moldovan Leu

2013 4,9%
2014 -4,7%
 Inflation is a major type of macroeconomic
disequilibrium.
Over the last 400 years there have been many
periods of inflation

Inflation has been defined as too much money

chasing too few goods

The word inflation from roman means swelling

 Inflation is the opposite of deflation.

Deflation occurs when the general

level of prices is falling.

Disinflation means the reduction in

the rate of inflation but not enough to
cause deflation.
The rate of inflation is
the rate of change of
the general price level
and is measured as
follows:
Price level = price index
Consumer price index

Producer price index

GDP Deflator
 The Consumer Price Index (CPI) is a measure of the
overall cost of the goods and services bought by a
typical consumer.

The CPI is reported each month.

It is used to monitor changes in the cost of living
over time.
When the CPI rises, the typical family has to spend
more money to maintain the same standard of living.
 The Statistical offices calculate other
prices indexes: e.g. the producer price
index, which measures the cost of a
basket of goods and services bought by
firms rather than consumers.
The GDP deflator reflects the prices of
all goods and services produced
domestically, whereas...
the consumer price index reflects the
prices of all goods and services bought
by consumers.
GDP Deflator vs. CPI
The consumer price index compares
the price of a fixed basket of goods
and services to the price of the
basket in the base year...
whereas the GDP deflator compares
the price of currently produced goods
and services to the price of the same
goods and services in the base year.

 Calculating the CPI
1. Fix the Basket
Statistical Offices identify a market basket of goods
and services the typical consumer buys.
2. Find the Prices
Find the prices of each of the goods and services in
the basket for each point in time.
3. Compute the Baskets Cost
Use the data on prices to calculate the cost of the
basket of goods and services at different times.
4. Choose a Base Year and Compute the
Index
Designate one year as the base year.
Compute the index by dividing the price of the
basket in one year by the price in the base year and
multiplying by 100.
Calculating the CPI
Example:
Base Year is 2002
Basket of goods in 2002 costs
1,200
The same basket in 2004 costs
1,236
CPI = (1,236/ 1,200) x 100% =
103%
Prices increased 3 percent
between 2002 and 2004

Moldova Previou
Prices Last s
Inflation Ra 6.50 4.70
te
Consumer P 100.80 100.70
rice Index
CPI
Producer Pr 104.60 104.00
ices
Food Inflat 6.00 4.50
ion
 1. TYPES OF PRICE INDEXES

1. The Laspeyres Index measures the

change in the cost of the market basket
purchased by the consumer in the original
year:
2. The Paache Index measures the change
in the cost of the market basket
purchased in the current year:

3. The Fisher Index

Types of the inflation
According to the character of inflation are
distinguished :
open and depressed inflation
Depending on growth rate of inflation three types
are defined:
Moderate(Ir<10%)
Galloping(10%<Ir<100%)
Hyperinflation(40-50%amonthormorethan
1000%oneyear)
Example:November,1923,Germany
1$=4,2trillionGermanmarks
19451946,Hungary,Priceindex=3,8x10 27
Types of inflation
According to the mechanism of action:

Demand-pullinflation

Cost-pushinflation

Builtininflation,inducedbyadaptive

expectations,oftenlinkedtotheprice-wage
spiral
According to the consequences two major types

of inflation are distinguished:

Anticipated

Unanticipated
Demand-pull inflation
Demand-pull inflation caused by increase in the AD.
Mechanismofthedemand-pullinflationisfollowing:
MADP
Reasons:highmilitaryspending
Budgetdeficit,NationalDebt
creditexpansionofBanks
additionalissueofmoney,highvelocityofmoney
circulation(V)
changesinthebehaviorofeconomicagents
Demand-pull inflation caused by increase in the
AD.

Mechanism of the demand-pull inflation is following: M

AD P
Cost-push
Cost-pushinflation
inflation caused by an
increase in the cost of production
and a decrease in the AS
P Cost of Production AS
Reasons: Lower productivity

an increase in the prices of imported

raw materials
an increase in wages of officials

dominated monopolism

trade-union regulation of Labor market

high indirect taxes

Cost-push inflation caused by an increase in
the cost of production and a decrease in the
AS
Mechanism of the cost-push inflation:
LRAS
P
P Cost of Production AS
SRAS 2




SRAS1
P2
E2

P1

E1

AD

Y2Y*Y
Built in inflation (price wage
spiral)
Mechanism of the inflation spiral price
wage
MADPWCostSRASPWADPWCo
stSRASPW and so on

Inflation spiral means the situation, in which
inflation is caused by demand and supply
factors. Action of one factor is determined by
the action of previous counterpart factor.

 Built in inflation (price wage
spiral)

P
P5 E5
P4
P3
P2 E4
P1
E3

SRAS3 AD3
E2
AD2

SRAS2 E1

SRAS1 AD1

Mechanism of the inflation spiral price wage

M AD P W Cost SRAS P W AD P W Cost SRAS P
W and so on
Inflation spiral means the situation, in which inflation is caused by
demand and supply factors. Action of one factor is determined by the
action of previous counterpart factor.
 Determinants of inflation
monetaryfactors(additionalissueofMoney,
budgetdeficit,highvelocityofmoneycirculation,
negativeconsequencesofGovernmentcredit-
monetarypolicyandsoon)
economic-productivefactors(highmonopolism,
changesinthecostofproduction,resultsof
incomepolicyofGovernment)
outsidefactors(importofinflation)
psychologicalfactors(rationalandadaptive
expectationsofbusinessandconsumers)
 CAUSES OF INFLATION
There are different schools of thought as to what causes
inflation.
Quantity theory of Money. M. Friedman said Inflation is
always and everywhere a monetary phenomenon.

EQUATION of the quantity theory of money: where:
MV PY Mmassofmoney
Pgeneralpricelevel
MV
P Vvelocityofmoney
Y circulation
YrealGDP
3reasonsofraisingprices:

M V Y
(additionalissue
ofMoney)

majorcause
Rational expectations theory: (ratex) that states that
economic factors look rationally into the future and do
not simply respond to the immediate opportunity cost
and pressures of the present. Future expectations and
strategies are important for inflation as well.

Neo-keynesian theory. A Fundamental concept is the

relationship between inflation and unemployment,
called the Phillips curve. General conclusion: price
stability is a trade off against employment or some
level of inflation could be considered desirable in order
to minimize unemployment.
 Phillips curve (short-run)
The Phillips curve shows the
trade off between inflation and
unemployment.
According to this view, a nation
can buy a lower level of
unemployment if it is willing to
U*
pay the price of a higher rate of
inflation.

U* U
 Phillips curve and its transformation into
stagflation curve (long-run)
(%peryear)
U*
Stagflationcurve
3 D
AII

2 C
AI

Phillipscurve

* A

1 B

U2U3U* U(%peryear)

The Phillips curve shows the trade off between inflation and
unemployment.
According to this view, a nation can buy a lower level of
unemployment if it is willing to pay the price of a higher rate of
People can prepare for anticipated inflation
by indexing incomes, benefits, loans.
Rational economic agents can take
anticipated inflation fully into account in
their actions and decisions and protect
themselves.

Common consequences of anticipated and

unanticipated inflation are following:

Purchasing power of money

1 , P is price level
PPM
P
Inflation tax

M t 1
Tinf.
Pt 1
flight from money

transaction cost (shoe-leather

cost, menu cost, cost of relative
price distortions, cost of
confusion and inconvenience)

outflow of capital

investment and saving are

discouraged
Real and Nominal Interest Rates
Interest represents a payment in
the future for a transfer of money
in the past.
The nominal interest rate is the
interest rate usually reported and
not corrected for inflation. It is the
interest rate that a bank pays.
The real interest rate is the nominal
interest rate that is corrected for
the effects of inflation.
Real and Nominal Interest Rates
Fisher effect describes the relationship
between inflation and both real and
nominal interest rates. The Fisher effect
states that the real interest rate equals
the nominal interest rate minus the
expected inflation rate. Therefore, real
interest rates fall as inflation increases,
unless nominal rates increase at the
same rate as inflation.
Fisher equation:
Nominal interest rate (i) = Real interest
rate (r) + Inflation rate
Real and Nominal Interest Rates
You borrowed $1,000 for one year.
Nominal interest rate was 15%.
During the year inflation was 10%.

Real interest rate = Nominal

interest rate Inflation
15% - 10% = 5%

 SPECIFIC CONSEQUENCES
OF UNANTICIPATED INFLATION:

Arbitrary redistribution of wealth:

from borrowers to lenders

from workers to business

from population with fixed income

to population with flexible income

from pensioners to young people
 Hyperinflation
If inflation is allowed to continue unmanaged, it can lead to a
state of hyperinflation.
Hyperinflation is a period of rapid inflation, causing the cost of
goods to double rapidly, sometimes in only a few months.
During hyperinflation:
a government's currency becomes practically worthless,
exports slow down,
foreign investment stops,
citizens begin to conduct business through more stable
currencies or by bartering,
the country's purchasing power is wiped out.
 Anti - inflationary Policy of
Government

active policy adaptive

policy

MAJORGOALS

1. tolimitednegative topreparefor
consequencesofinflation anticipatedinflation
1. toeliminatesourcesof
inflation
2. toprovidepricestability
 MEASURES

Monetary :
1)controloverissueofM Indexationof
wages,pensions
2)controloverlendingabilityofcreditinstitutions
(toolsoftightcredit-monetarypolicy)
Compensationof
3)nullificationofmonetaryunit
losses
Non-monetary :
1) Against Demand-pull inflation Supportingthewell-
Public expenditures beingofpopulation
Tax rate
Budget deficit
2)Against Cost-push inflation:
antimonopoly regulation
introduction advanced technologies (cost of
Production , Production )
wage and price controls
structure policy of Government