3.4 - Price Stability

what is price stability

when the general level of prices stays constant over time

what is inflation (one of the main macroeconomic objectives)

the sustained rise of the general price level over time

what is the governments aim of price stability for the economy

target of 2% +/- 1% inflation rate

what is the rate of inflation

% rise in the general price level over time

why is real price stability important

impacts the cost of living

how is inflation measured mainly

the consumer price index CPI which is a ratio that measures changes in price level and is expressed as a percent of a base value which is always 100 (so if the index becomes 103 after one year, there is 3% inflation)

how is inflation recorded / measured

the ONS puts together a shopping basket of goods and services based on a household spending survey and then track the prices each month. the basket gets changed every year to accurately reflect consumption

why do some goods and services get weighted according to the amount spent on them by a household

because a price rise for some goods and services will have a bigger impact due to the proportion of households money spent on it

what are the causes of inflation

demand pull inflation - excess demand in the economy

cost push inflation - increased price due to increased costs in the economy

what is the wage price spiral

initial rise in general price level leads to workers demand higher wages to compensate leads to rising wages leads to costs of production for firms rising so firms raise the price of their goods and services leads to the general price level rising further and this repeats

what are consequences of inflation for consumers

savers lose but debtors gain

loss of confidence - how can you plan ahead if prices keep rising

shoe leather costs - time is money so time spent looking for best deal wastes money

real incomes may fall - impacts those in labour market with little power and those with non index linked incomes

income redistribution issues

what are consequences of inflation for producers

more flexibility - easier to adjust prices / wages

menu costs - firm might have to keep changing their menu

labour market conflicts - workers demand more

loss of international competitiveness

hard to plan investment decisions without price stability

if businesses are in debt it lowers it

what are consequences of inflation for government

gains as a debtor - has the biggest debt in the country

has to pay out more if benefits are index linked

may have to pay public sector workers more

naturally receives more tax revenue - VAT and income tax especially

may have to introduce policies to deal with inflation

what is hyperinflation

inflation at an extremely high rate

what is stagflation

high inflation and low growthh

what are the positives and negatives of 0% inflation

it is great in the short term as it boosts real wages however some inflation is good as it allows businesses to increase their prices and make more profit and debtors are helped out and it gives price opportunity to adjust in different markets. also no inflation could mean that workers will think their pay rise is low and not be motivated and a low rate might reflect a lack of demand in the economy so confidence drops

what is deflation

falling prices on average

what is disinflation

prices rising at a slower rate

how do you solve inflation (demand)

fiscal policy - reduce benefits and increase taxes which reduces demand

monetary policy - increase interest rates which reduces demand

how do you solve inflation (supply)

supply side policies - increase supply