Inflation and deflation

Inflation

The sustained rise in the general price level over time, resulting in an increase in the cost of living and a decrease in the purchasing power of money.

Deflation

The opposite of inflation, where the average price level in the economy falls, resulting in a decrease in the cost of living and an increase in the purchasing power of money.

Disinflation

The falling rate of inflation, where the average price level is still rising, but at a slower extent.

Consumer Prices Index (CPI)

A measure used in the UK to calculate the inflation rate, which measures the average price change of a basket of goods and is updated annually.

Retail Price Index (RPI)

An alternative measure of inflation that includes housing costs, such as mortgage interest and council tax, resulting in a higher value than CPI.

Demand pull inflation

Inflation caused by an increase in aggregate demand, usually occurs when the economy is at full employment because output cannot increase further price increases due to scarcity. Often triggered by factors such as a depreciation in the exchange rate, fiscal stimulus, lower interest rates, or high growth in export markets.

Cost push inflation

Inflation caused by rising costs faced by firms, such as changes in world commodity prices, increased labor costs, expectations of inflation, indirect taxes, depreciation in the exchange rate, or monopolies exploiting consumers.

Wage-price spiral

An increase in wages leads to higher disposable income and increased aggregate demand, which puts upward pressure on the average price level. Workers then demand higher wages to keep up with inflation, further increasing the price level, creating a loop where prices and wages keep increasing.

Growth of the money supply

An increase in the money supply, usually caused by actions such as quantitative easing, can lead to inflation if it exceeds the rate of real output growth.

Effects of inflation on consumers

Inflation negatively affects those on low and fixed incomes the most, as the cost of necessities becomes more expensive and the purchasing power of money falls. However, those with loans may benefit as the real value of debt decreases.

Effects of inflation on firms

High inflation can lead to higher interest rates, making borrowing and therefore investment more costly. Firms may also face higher labor costs and reduced price competitiveness on a global scale.

Effects of inflation on the government

The government may have to increase the value of state pensions and welfare payments to account for the increasing cost of living. The government may have to increase borrowing or cut spending in other areas due to higher costs.

Effects of inflation on workers

Real incomes fall with inflation, resulting in less disposable income. Higher costs for firms may also lead to job cuts and redundancies.

Effects of deflation

Deflation causes the real value of money to increase, making goods and services cheaper in the future. This can discourage spending and lead to economic decline, increasing rates of unemployment. It also makes the real value of debt higher, making it harder for consumers with high levels of debt to pay it off.

Money supply

The total amount of money available in an economy at a given time.

National income

The total income earned by individuals and businesses within a country's borders in a specific period.

Price level

The average level of prices for goods and services in an economy.

Supply-side factors

Factors that affect the production and supply of goods and services in an economy.

Deflationary fiscal policy

Government policies aimed at reducing aggregate demand and decreasing inflation, such as cutting government spending or increasing taxes.

Deflationary monetary policy

Actions taken by a central bank to reduce the money supply and decrease inflation, such as raising interest rates or selling government securities.