Lecture 6 - Inflation (4)

headline CPI vs. core CPI

headline = normal, core = everything - food and energy

CPI calculation

CPI = basket’s cost in current yr / base yr price * 100

inflation rate calculation

= CPI2023 - CPI2022 / CPI2022 × 100

problems w/ CPI

(1) substitution bias - misses this bc it’s a fixed basket of goods (PCE features changes)
(2) introductino of new goods - new goods increases variety, therefore dollars become more valueable and CPI misses this
(3) unmeasured quality changes - sometimes prices rise bc of increases in quality, not necessarily due to inflation

**in all 3 cases, CPI overstates cost of living

GDP deflator vs. CPI

CPI focuses on consumers and looks at cost of living changes for consumers

GDP deflator measures price change across a set of G+S across whole economy

CPI includes imports, GDP does not

CPI excludes exports, GDP includes exports

CPI excludes capital goods, GDP includes capital goods

**GDP does not use a fixed basket

hyperinflation

inflatoin of 50% in one month

amount in today’s dollars

amt in today’s dollars = amt in yr T (price level today / price level in yr T)

indexation

a dollar amount is indexed for inflation if it’s automatically corrected fo rinflation y law or in a contract

increase in CPI automatically determines:

• the COLA (cost of living adjustment) in many multi-yr labor contracts

• adjustments in social security payments and federal income tax brackets

what’s wrong w/ inflation?

winners and lsoers based on poor or not, workers lose, net lenders/borrowers, it feels risky bc people don’t know what to buy and it makes future prices feel uncertain

**also people on fixed nominal income have lower real value of income

menu costs

uncertainty

confusion and inconvenience - complicates long range planning

healthy inflation

gives monetary policy room to move

also allows companies to cut real wages instead of nominal wages

causes of inflation

(1) cost-push - input prices rise —> their prices rise too

(2) demand-pull - movement along the phillips curve bc of rise in AD

(3) expectations driven - rise in inflation bc of a shift in the phillips curve due to change in people’s expectations about inflation

**phillips curve moves w/ changes in ideas about inflation

expansionary monetary policy

cutting interest rates

contractionary monetary policy

raising interest rates

why has the phillips curve flattened?

bc inflation expectations have been anchored pretty strongly

other factors:

• globalization

• decrease in worker power

• labor market isn’t as tight as low unemployment suggests

• e-commerce