Inflation Macroeconomics

Inflation… what is it?

An increase in the economy’s price level

The price level is the weighted average of prices

A decrease in money’s purchasing power

What causes inflation

• 2 immediate causes (what starts it)

– Demand-pull– Cost-push

• Ultimate cause (what sustains it)– Too much money chasing too few goods

• This can lead to hyperinflation• The wage-price spiral

How’s inflation measured

• Consumer Price Index (CPI)– Used to measure consumer inflation– Market basket approach– Quick, efficient– Ignores consumer substitution, quality changes

• GDP deflator– Measures entire economy’s inflation– Includes everything– Used to deflate nominal gdp

2 ways inflation is reported

CPI Headline inflation

Includes entire CPI market basket

CPI Core inflation

Excludes food and energy because they are volatile

Who does inflation effect?

Everybody

Who wins?

Those with large debt

Those who borrowed at low fixed interest rates

Those who make fixed payments

Who loses?

Those with large cash savings

Those who lent at low fixed interest rates

Those receiving fixed payments

Expectations

Expecting inflation causes inflation

Consumers demand more

Producers supply less

The role of the central bank

Control actual inflation by controlling expected inflation

The importance of credibility

Disinflation and Deflation

• Disinflation– Decrease in the inflation rate

• Going from 7% inflation to 2% inflation

– Disinflation is good for the economy– Referred to as price stability

• Deflation– Negative inflation rate

• prices falling

– Deflation is bad for the economy– Creates perverse incentive to delay spending on durable goods and capital

investments