Cambridge IGCSE® and O Level Economics Coursebook (Cambridge International IGCSE) - Second Edition (Grant, Susan) (Z-Library)

Inflation and Deflation

31.5 Policies Available to Control Inflation

• Inflation Rate Targeting

  • Governments set an inflation rate target for central banks.

  • Aims for accountability and influences behavior of households and firms.

  • If the target is not met, the central bank must explain why and what measures will be taken to return to target.

• Contractionary Policies for Demand-Pull Inflation

  • Involves increasing tax rates, lowering government spending, raising interest rates, or reducing the money supply.

  • Effectiveness impacted by consumer and firm confidence.

  • Can lead to economic growth reduction and increase in unemployment.

• Cost-Push Inflation Control

  • Utilize supply-side policies, e.g. improved education or privatization.

  • This approach can be costly and take time to implement.

31.6 Causes of Deflation

• Supply-Side Causes

  • Advances in technology and productivity can drive prices down.

• Demand-Side Causes

  • Falling aggregate demand can lead to harmful deflation, where consumers hold off spending, reducing firm output and employment.

31.7 Consequences of Deflation

• Good Deflation

  • Caused by increased aggregate supply; potentially benefits trade balances.

  • Associated with rising output and employment.

• Bad Deflation

  • Results in increased unemployment, decreased output, discourages investment.

  • Raises purchasing power of remains constant income, but increases debt burden.

31.8 Policies Available to Control Deflation

• Expansionary Policies

  • Use expansionary fiscal and monetary policies during bad deflation risks.

  • May be difficult if inflation rates are already low, and confidence is low.

• Examples

  • Greece's deflation 2013-2016 included cuts in wages and pensions amid recession.

31.9 Policy Conflicts

• Inflation vs Unemployment

  • Some policies to cut unemployment (e.g., increased pension spending) can raise inflation.

  • Tax increases to control imports may reduce economic growth and exacerbate unemployment.

• Macroeconomic Policy Responses

  • Contractionary policies designed to lower inflation can slow growth and increase unemployment.

Summary of Key Terms

• CPI: Consumer Price Index, a measure of inflation.

• Inflation Causes: Cost-push (wage & raw material increases), demand-pull (high demand in full employment).

• Inflation Effects: Reduces purchasing power, can redistribute income and impact savings.

• Deflation: Can be driven by supply or demand; affects employment, growth, and consumer behavior.

• Protectionism: Trade restrictions to support domestic industries.