Inflation & Monetary Policy

inflation

sustained rise in the general price level of goods and services

deflation

a decrease in the general price level

disinflation

a decrease in the rate of inflation

consumer price index (CPI)

the price of a representative basket of goods and inflation as a percentage change

what issues does inflation bring

• uncertainty

• struggle to distinguish between changes in relative price and inflation

• create a greater burden depending on a consumer’s income

who are considered the ‘winners’ of inflation

borrowers, flexible-income recipients and possibly government

who are considered the ‘losers’ of inflation

creditors, fixed-income recipients, savers, low-income households

what issue does the inflation rate cause

biases that have an impact on its accuracy

what biases does the inflation rate bring

• substitution bias

• quality bias

• new product bias

• outlet bias

• formula bias

• aggregation bias

what issue does deflation bring

it increases the real debt burden, which may lead households to cut consumption to return to their target wealth

what does an upswing in the business cycle indicate

a rise in inflation

when does a wage-price spiral continue in the economy

if unemployment is below the labour market equilibrium unemployment level

how can you stop a wage-price spiral

employment levels need to decrease the level associated with the labour market equilibrium

when are prices stable

when the labour market is in (Nash) equilibrium

what is inflation-stabilising unemployment

a tradeoff between extra output and inflation

what is the SARB inflation target range

3-6%

what are the functions of the SARB

• issue notes and coins

• banker to the government

• custodian of banks’ cash reserves

• custodian of foreign reserves

• custodian of last resort

positive bargaining gap in boom leads to…

inflation

negative bargaining in boom leads to…

deflation

how does an expansionary monetary policy work

• SARB buys bonds, lowers reserve ratio or lowers the repo rate

• excess reserves increase

• money supply rises

• interest rate falls

• investment spending increases

• AD increases

• real GDP rises

how does a restrictive monetary policy work

• SARB sells bonds, increases reserve ratio or increases the repo rate

• excess reserves decrease

• money supply falls

• interest rate rises

• investment spending decreases

• AD decreases

• inflation declines