inflation

Section 18

A Low and Stable Rate of Inflation

Define Inflation

A persistent increase in the average price level of the economy, usually measured through the calculation of a consumer price index

Costs of Inflation (the reasons governments want to keep inflation low and stable)

Loss of Purchasing Power	Loss of purchasing power- if the inflation rate is higher than your rate of wage increase you will experience a loss of purchasing power -          People on fixed incomes or people without COLAS built into their contracts will suffer -          Also the role of expectations is important because wage contracts are agreed to in advance of inflation data
Effect on Savings	If the rate of inflation is higher than your interest rate you will experience negative savings. -          Inflation discourages savings though you can offset the effect on savings by purchasing assets whose value rises faster than inflation.
Effect on Interest Rates	Effect on interest rates- high rates of inflation cause banks to raise their nominal interest rates to avoid losing profits from lending money.
Effect on international competitiveness	A high rate of inflation causes a negative balance of trade -          Exports are less competitive and unemployment in export industries may result -          Imports from lower inflation trading partners become attractive
Uncertainty	Inflation causes reduced investment due to the fall in available loanable funds savings, higher interest and uncertainty in the marketplace, this negatively affects economic growth.
Labor Unrest	If labor does not feel their wages are keeping up with inflation it may cause disputes between unions and management

Define Deflation

A persistent fall in the average level of prices in the economy Good- results from the improvements in the supply side of the economy and/ or increased productivity Bad deflation- results from decreased aggregate demand. If output reduces it is assumed that the level of unemployment will wirse because firms will need fewer workers to produce less output

Good Deflation (improvements in the supply side of the economy)

 

                                       

Bad Deflation (source in demand side of the economy)

Disinflation

A slower rate of growth and inflation

Costs of deflation

Unemployment	When AD is low , business are likely to lay of workers and can lead to a deflationary spiral. -          If prices are falling consumers may delay purchases (deffered consumption), reduce AD and lead to lay offs. This in turn lowers consumers confidence and process repears
Effect of Investment	During deflation businesses make less profit or experience losses causing them to lay off workers and reduced investment
Costs to Debtors	Anyone who has taken a load suffers because the value of debt rises as a result of deflation

How is inflation measured? CPI/RPI

Choose rep. basket of consumer goods or services

Price of sample

Measure monthly by collectors from retailers

Catergorized and weighted

Issues (Limitations) involved in the measurement of inflation

Typical Market Basket	Basket not applicable for all people
Collection Errors	Errors in the collection of data
Market Basket Changes Affect comparisons over time	Differences counted by making changes in the market basket
International collection differences	Different countries measure inflation in different ways
Un-sustained price changes	Price may not change for a varety of reasons that cannot be sustained
Other Measures Value	Only measures changes in consumer prices

Causes of Inflation:

Demand-pull inflation

 

Cost-push inflation

 

Demand-pull and cost-push inflation together (Inflationary spiral)

 

Monetarist viewpoint (Inflation due to excess monetary growth)

 

Reducing Inflation (depends on type)

Reducing Demand-Pull Inflation

1.using deflationary fiscal policy:increase taxes or reduce gov. spending

2.deflationary monetary policy increase the prime interest rate, decrease the money supply

Problems with deflationary AD policies

1.raising taxes is unpopular

2.reducing gov spending impacts a variety of groups and may result in less support for the gov.

3.higher interest rates hurt home owners making mortgages more expensive

4.governemts worried about reelection will be reluctant to use these methods to reduce AD

Widely accepted (best) way to reduce demand-pull inflation:

Using monetary policy to lower AD carried out by central but def mon. pol. Increase I lower Ms

Why?

Central bansks not politically motivated

Reducing Cost-push inflation

Supply-side policies (market-based) [Why not interventionist?]

1.labour market reform

2.privatization

3.deregulation

4.increase competition

5.decrease corp taxes

6. decrease household taxes

Reducing inflation Monetarist Viewpoint:

The solution is to increase money supply at the same level of growth

Problems facing governments:

Trade-off between different policy objectives.

Inflation - unemployments

Difficulty in distinguishing the type of inflation.

Calculating Inflation

Non-weighted/equal weighting/weighting

Inflation Rate =

Inflation-unemployment trade-off debate

The Phillips Curve

Presented by New Zealander economist:

Based on a UK study of the economy from:

Stated:

Low unemployment → firms pay higher wages to attract labor

Unemployment high → workers compete to obtain jobs so wages relatively low

Showed inverse relationship between rate of change of wages and unemployment rate. The rate of change of wages could actually become negative in times of high unemployment.

Original Phillips Curve

 

Concept expanded by other economist to correlate it with inflation rate and unemployment rate using data from other countries.

Phillips Curve

 

Phillips Curve using AD/AS analysis

 

Long-run Phillips Curve

Economic growth

Economic growth

Economic Growth Using graphs to show economic growth	Third goal is economic growth An increase of GDP over time Different countries go through different levels of economic growth Demand side factors may be used to bring short term growth http://dineshbakshi.com/images/stories/economics_diagrams/deflationary-gap.jpg http://dineshbakshi.com/images/stories/economics_diagrams/output-gap.jpg resources are not being used to the fullest extent possible economic growth is achieved when AD1 shifts right ant a moves to B http://dineshbakshi.com/images/stories/economics_diagrams/economic-growth-ppc.jpg long term as an increase of ouptut or potential output a shift in the LRASE leading to shift in PPC
Consequences of economic growth Positive consequences	Brings benefits but also negatives Aggregate demand tends to increase as pop and incomes grow This leads to inflation However when economic growth accurs pushing out the aggregate supply curve economies can experience non-inflationary growth Income of the average person will increase and this may be equated with a higher standard of living.- material living standard have improved Not only been achieved but led to increases in technology Lead to higher living standards lead to higher tax revenues more money to spend on public goods, merit goods and reduce income inequalities increase trade with other counties and has a very positive impact on living standards There is an increase in education and human capital
Negative consequences	Some argue that an increase in growth does not necessarly mean an increase in happiness Sacrifice leisure time, neglect personal relationships Greater material wants make us more and more unahppy Structual unemployment occurs as sectors shift Enviromental destruction, more waste, Wealthier citizens can demand policies that promote sustainabily
Summary	Deflationary gaps may be the result of a fall in economic growth and may be solved using demand management policies. supply side policies effect the business cycle and generate long term growth. Growth rate= (real gdp in year 2- real gdp in year 2)/real gdp in year 1)=100

HL2 BW 0007

1.       Outline/ expain the typical role and responsibilities of a central bank

Sets interest, sell bonds, makes inflationaru expectaitions and ensture I stays within that range

2.       Explain why core inflation is important to monitor

The core inflation, influence after excluding goof food and energy prices/ relatively elastic and volatile, gives a more reliable value for inflation as the commodities are the most volatile aspect of it. 

STAMPED UPWARDS!

Inflation hmw

7.

1) False

because if lower interest rates, you're increasing investment, which increases AD and through an increase in C and I whih causes inflation

*loans

3) true. if expect inflation, negotiate for higher wages which increases the cost of production

2) True because inflation decreases the value of loand

4) False. If from keynsian perspective, shift in AD does not result in a change in price level

5) True. CPU us better bc more widely accepted

6) True. inflation causes a decreases in the value for money

7) true bc low prices appeal to foreigners

8. True bc its a leftward shift of AS which causes the Philips curve to shift right

9) false bc money allusion only occurs in the longrun

10) govt. credibility is a key influence on inflation rates

10.

a.

Year	Price of book	Price of an mp3 downlaod	Price of a burger
2009	6.50	0.99	2.50
2010	6.60	1.05	2.55
2011	6.40	1	2.40

year	P1q1+p2q2+p3q3	Cost of basket
2009	6.5x5+0.99x12+2.50x20	94.38
2010	6.6x5+1.05x12+2.55x20	96.6
2011	6.4x5+1.00x12+2.40x20	92

year	formula	Price index
2009	94.38/94.38	100
2010	96.6/94.38	102.35
2011	92/94.38	97.47

Year	Inflation rate
2010	-
2011	(102.35-100)/100x100{2.35%
2012	(97.47-102.35)/100x100{-4.88

inflation BW

Bell work 10/09/2012

1.       Explain the reasons gov. aim to maintain a low and stab rate of inflation.

There are many costs to inflation and deflation and this is why gov. aim to mainatain a low and stable rate of inflation

Loss of purchasing power- when inflation rises faster than wages, people lose purchasing power.

Effects on savings- when inflation ries faster than the interest rate, negative savings can occur.

Effects on interest rates- when inflation occurs, banks mist raise interest rates in order to maintain profits from lending money

Effects on international comp.- when inflation occurs, goods produced domestically become less appealing to foreigners.

Uncertainty- when inflation occurs and banks raise interest rates, business confidence drops, uncertainty occurs and firms spend less on investment.

Labor unrest- if labor feels wages are not kept up with inflation- disuputes and riots occur

Costs of deflations

Unemployment- when AD is low, businesses tend to lay of workers

Effects on investment- during deflation firms make less, they then lay of workers

Costs to debtors- value of loans decrease

2.       What is the difference between deflation and disinflation?

Disinflation is a slower rate of inflation, inflation is still going up, just at a slower pace

Deflation is a negative inflatin rate

3.       Which is worse inflation or deflation? Why?

Argued that deflation is worse since the country will experience less output, experience unemployment and possible fall into a deflationary spiral

work sheet on

Low Unemployment Worksheet

Objective 1: Explain what is meant by unemployment.

Define the following:

Unemployment	People of working age who are without work but are available for work and  are actively seeking work.
Unemployment Rate	Number of people unemployed expressed as a percent of the labor force
Labor Force	Definition varies from country to country but includes people willing, able and wishing to work between the legal work age and retirement.

Objective 2: Explain the difficulties involved in measuring unemployment.

Limitations of unemployment data:

Unemployment definition inconsistencies	Depends from country to country so we can not compare
Data collection inconsistencies	Different countries collect their data is in different ways
Masks Distribution Disparities	Ethnicities Age Gender
Hidden Unemployment	Discouraged workers- someone who has given up on looking for a job Part-time workers- half time work, not enough Underemployed workers- over qualified for the job they are doing

 Objective 3: Discuss the costs of unemployment.

Costs to unemployed themselves	No income, low standards of living, possible suicides
Costs to society	Opp. Cost, Poverty, higher rates of crime, vandalism, increased gang activiety
Costs to               whole economy	Producing within the ppc curve Opp cost to the government

Objective 4: Distinguish between the different causes of unemployment.

Inflows- cause unemployment rate to rise

Lost jobs

Resignment

People who have left school

People trying to return to work after having left it

People who have imigrated

‘Pool of Unemployed’

Outflows- cause unemployment rate to drop

People who have found jobs

People who retire

People who go back to education

People who choos to stay at home

People who emigrate

People who give up the search for work

People who passed away

The labor market in equilibrium

 

Types and causes of unemployment.

a)      Disequilibrium unemployment-occurs when there are any conditions that prevent the labor market from clearing

b)      Real wage-unemployment

Argues that unemployment is caused by trade unions and government minimum wages altering with labor market

 

Solutions for real wage unemployment.                                                  Consequences of the solutions.

Reduce trade unions to unfluence wages	Politcaly un popular Harms poor the most Causes greater income inequality
Reduce minimum wage

a)      Demand-deficient (cyclical ) unemployment- as countries enter a period of slow growth c and I go down which leads to a decrease in aggreagate demand but because wages are sticky downward so unemployment results

 

Solution for demand-deficient unemployment.

Expansionaray policicits fiscal monetary	Lower taxes increase gov spending
	Lower interes rates increase money supply

c)       Equilibrium Unemployment- (equal to the natural rate of unemployment or full emplyent elevel output) occurs when there is no real wage or demand defiant unemployment; still some natural unemployment excists (frictional season structure)

 

a)      Frictional Unemployment- short term unemployment when people are between jobs or have left education and are waiting for a job. *people usually move up though.

Solutions for Frictional Unemployment

Market based : ensure unemployment benefits are not too generous

Interventionis: ensure flow of information about existing jobs is good

b)      Seasonal Unemployment- when employment occurs on a seasonal babsis again- intuitively natural; ie construction workers in cold climate.

Solutions for Seasonal Unemployment

Improve the flow of imformation Encourage seasonal workers to ake new jobs

c)       Structural Unemployment- results when a particular type of labour is no longer needed, due to a number in structure within the economy likely to result in long term unemployment

Causes of Structural Unemployment

Wworkers lack skills to take new jobs

Lack occupational mobility

Lack geographic mobility

New technologies (atm)

Outsourcing call centers

Consumer taste

Interventionist solutions to structural unemployment                                                      Evaluation of solution

Use an edu system that trains people to be occuplationally flexible	Only effective long term
Increase gov on adult retraining programs
Subsidizes to firms that provide worker training	Opp costs
Subsidies – tax breaks to encourage geographic mobility	Expensive
Gov support of apprentice programs

Market-based Solutions for Structural Unemployment

Lower unemployment benefits to increase incentive for people to take existing jobs	Increase income inequality
Lowe labor market regulations to make it easier for firms to hire/fire	Working conditions+ hugh costs to workers themselves

Analysis of unemployment reducing policies

Solution to unemployment- dependent on type- hard to determine

Demand deficient Expansionary fiscal policy ofton requires budget deficients

Lower taxes does not always mean. People may choose to save and not spend

Lowering interest rates does not mean and increase in investman, depends on business confidence

If AD policies successful- there will be likely be a time lag

Even at yf there will be some unemployment Have to be careful to avoid ad policies at yf due to inflation

Most common/ acceptable to use mix of demand and supply side politics

Crowding out-

The concept that when govs run budget deficits to increase AD and reduce unemployment they ‘crowd out’ busineses and private individuals from loanble funds market causing interst rates to increase and I to decrease.

Keynesian viewpoint on Crowding-out:

  Classic viewpoint on crowding out:

bell work for equilibrium and disequilibrium

http://imgur.com/93xqu