Inflation and Deflation Lecture Notes

This set of vocabulary flashcards covers the measurement, limitations, causes, and consequences of inflation and deflation, as well as government policy responses as detailed in the lecture transcript.

Inflation

A sustained, inordinate, general increase in the price level over time.

CPI (Consumer Price Index)

A measure of inflation based on a basket of goods consumed by the average household.

Basket of Goods

A collection of goods and services consumed by the average household, used to measure price changes; its contents may become outdated as tastes and preferences change.

Base Year

A year of reference used for comparison in an index, typically assigned an index value of $100$, chosen such that it has no major economic challenges.

Weights

The percentage share of income spent on certain goods; a high weight indicates a larger percentage of income spent on that item.

Real Income

Money income in terms of what it can actually buy; it falls when the cost of living increases due to inflation.

Redistributive Effect

The movement of wealth between borrowers and lenders; borrowers gain during inflation if interest rates do not rise in line with inflation, while lenders lose due to a lower real rate of return.

Shoe Leather Cost

The time wasted by consumers looking for better bargains or lowest interest rates as they move funds between institutions during periods of inflation.

Menu Cost

The cost to firms associated with price instability, specifically the expense of updating price tags, websites, and advertising campaigns.

Demand-Pull Inflation

Inflation occurring on the demand side due to sudden increases in consumption or investment when the economy is already at full employment.

Supply Shocks

Increases in the cost of production, such as raw materials, wages, or rent, which force firms to raise prices to maintain profit margins.

Wage Spiral

A cycle where increases in the cost of living lead workers to make wage claims, which, if granted, lead to higher prices to cover costs, eroding purchasing power again.

$$MV = PY$$

The equation used by Monetarists where $M$ is the money supply, $V$ is the velocity of circulation, $P$ is the price level, and $Y$ is the national output.

Deflation

A sustained decrease in the general price level of an economy.

Anticipated Inflation

Inflation that is expected by economic agents, allowing them to adjust behavior, such as negotiating wage contracts or adjusting interest rates, to minimize economic harm.

Contractionary Monetary Policy

A government policy that influences interest rates, the money supply, and the exchange rate to reduce inflationary pressure.

Open Market Operations (OMO)

A method used by the government to control the growth of the money supply by selling securities.

Cash Reserve Ratios (CRR)

The percentage of new deposits that commercial banks are required to keep, used as a tool to control their lending ability.

Marshall-Lerner Condition

A condition used to determine if a currency devaluation will improve the Balance of Payments, expressed as the sum of price elasticities of demand for exports and imports being greater than one ($PEDx + PEDm > 1$).

Indexation

The practice of adjusting payments such as pensions or wages in line with inflation to prevent a loss in real income.