Inflation/deflation

Define inflation

Sustained increase in the general price level leading to a fall in the purchasing power of money

How is inflation measured

Annual %age change in consumer prices using the Consumer Price Index

What is the CPI

Consumer Price Index - the price level on a collection of products designed to reflect the consumption basket of an average consumer

What are the significant years in UK inflation

• 5% - Jul 2008

• 1% - Oct 2009

• 5% - Nov 2011

• 0,25% - Mar-Aug 2015

• 11% - Oct 2022

What is the target inflation rate by the BoE

2%

Define hyper-inflation

A period of extremely rapid inflation leading to loss in value of a currency

Define disinflation

A fall in the rate of increase of prices - a slowdown of inflation so consumer prices are still rising but at a slower rate

Define deflation

An annual inflation rate below 0% causing a decline in GPL

What are causes of inflation?

• Money and credit boom

• Higher wage costs

• Increased energy bills

• Falling exchange rate

• Economic boom

What is stagflation?

Stagnant/ slow economic growth, rising unemployment and high and rising inflation

What are inflation expectations?

Describes what people and businesses expect to happen to consumer prices in future

What is a wage-price spiral?

When people expect high inflation so ask for high wages to make up for this. If employer gives higher wage, this

What is cost-push inflation?

When businesses respond to rising unit costs by increasing prices to protect profit margins. Includes

• Rising labour costs

• Higher raw material prices

• Rise in imports due to depreciation of currency

• Increase in indirect taxes

Give an example of real world cost push inflation

In the 1970s world oil prices rose dramatically causing UK inflation to rise up to 30%

What is demand pull inflation

When rapid growth in aggregate demand causes inflation because businesses take advantage of high demand, raising prices to increase profits

What does capacity have to do with inflation?

The closer an economy is to full capacity, the more rapid the inflation

What are the causes of demand pull inflation

• Economy growing too quickly 

• Low interest rates encouraging more spending and borrowing

• Excessive fiscal stimulus like tax cuts or increased spending

What is monetarism and who was its leading advocate?

Monetarism suggests that the amount of money in the economy plays a huge role in inflation. Milton Friedman was a leading advocate and believed increasing money supply too rapidly can lead to inflation

What is the Fishers Equation of exchange?

MV = PQ

M= money supply

V = velocity of money

P = price level

Q = quantity of goods and services produced

What is the Quantity theory of money

When an economy’s money supply is increased more quickly than thr growth rate, we can expect inflation

What was the inflation rate between 2022-2023 and why was it caused?

11%. It was caused by 

• Pandemic causing supply shortages - demand greater than supply e.g. food

• Conflict in Ukraine - spike in energy prices

• Labour shortages - pushed up wages for those available and therefore costs

Define greedflation

Charging excessive and unreasonable prices due to increased demand and limited supply. Sellers charge much higher than what would be reasonable under normal market conditions

What is shrinkflation?

When sellers maintain the price of a good or service but reduce the quantity or size produced

What are economic problems with inflation

• Inequality = regressive effects on lower income families and those with cash or fixed income assets will lose out

• Falling real incomes - wage rises lag behind inflation

• Negative real interest rates - cut real income of savers

• Risks of wage price spiral leading to more inflation

• Can reduce business competitiveness lowering export demand

• Business uncertainty - difficult for businesses to plan investment

What are policies to control inflation

• Increases in interest rates and tightening of credit supply/bank lending

• Contractionary fiscal policy - higher direct taxes and austerity

• Supply side policies

• Labour market reforms to increase supply

What are examples of supply side policies to control inflation?

• Expansion of the worker-visa programme to encourage more skilled workers into the UK

• Policies to encourage house building and address rent inflation

• Infrastructure investment to lower business costs

• Subsidising business production or set up costs (especially for merit goods)

What will higher interest rates do to the exchange rate?

Cause appreciation of exchange rate = cheaper imports more expensive exports

What is malign deflation?

Demand side inflation

Persistent fall in the general price level, output and employment. Caused by persistently low levels of aggregate demand and high levels of spare capacity

What is benign deflation?

Supply side deflation

Fall in the general price level caused by an outwards shift of the SRAS curve.

• Lower unit costs of supply can drive prices lower as businesses are able to supply more.

• Strong exchange rate causing low import prices

• Technological advancements that lower unit costs and improve productivity of labour and capital

What are the economic effects of deflation?

• Lower spending if prices are expected to fall

• Real value of debt increases causing lower consumer confidence

• Real cost of borrowing increases as real interest rates rise

• Lower profit margins = higher unemployment

• Falling asset prices hits personal wealth and confidence

• Redistribution of income from debtors to creditors - debtors may default on loans

What are the opportunities with deflation?

• Falling general prices may increase real incomes of poorer families

• Can be a rise in demand of value products - more value for money

• Asset prices falling can improve housing affordability