Topic 5 Inflation
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Transcript of Topic 5 Inflation
Content
Inflation and its measuring Types of inflation Causes of inflation Cost of inflation Inflation and unemployment. The
Phillips curve Anti-inflationary policy
Inflation rate in different countries: USA – 2% (2012) UE - 2,6% China -3,1% India -6% Belarusia-59,1% Moldova -4,5%
Dynamics of the Inflation Rate in the R. Moldova
(1993 - 2008)
Year π (%) Year π (%)1993 2705,7 2004 12,5
1994 104,6 2005 10,5
1995 23,8 2006 14
1997 11,2 2007 13,1
1998 18,3 2008 7,3
1999 43,3 2009 12,5
2000 18,4 2010 8,1
2002 4,4 2011 7,8
2003 15,7 2012 4,5
November, 29, 1993 – the introduction of Moldovan Leu2013 – 4,9%
Inflation is a major type of macroeconomic disequilibrium.
Over the last 400 years there have been many periods of inflation
Inflation has been defined as “too much money chasing too few goods”
The word “inflation” from roman means “swelling”
Inflation is the opposite of deflation.
Deflation occurs when the general level of prices is falling.
Disinflation means the reduction in the rate of inflation but not enough to cause deflation.
TYPES OF PRICE INDEXES
1. The Laspeyres Index measures the change in the cost of the market basket purchased by the consumer in the original year:
2. The Paache Index measures the change in the cost of the market basket purchased in the current year:
3. The Fisher Index
Types of the inflation According to the character of inflation are
distinguished : open and depressed inflation Depending on growth rate of inflation three types
are defined: Moderate (Ir < 10%) Galloping (10%< Ir <100%) Hyperinflation (40-50% a month or more than
1000% one year) Example: November, 1923, Germany 1$ = 4,2 trillion German marks 1945–1946, Hungary, Price index = 3,8 x 1027
Types of inflation According to the mechanism of action:
Demand-pull inflation Cost-push inflation Built – in inflation, induced by adaptive
expectations, often linked to the “price - wage spiral”
According to the consequences two major types of inflation are distinguished: Anticipated Unanticipated
Demand-pull inflation Demand-pull inflation caused by increase in the AD. Mechanism of the demand-pull inflation is following:
M↑ AD↑ P↑ Reasons: high military spending Budget deficit, National Debt credit expansion of Banks additional issue of money, high velocity of money
circulation (V) changes in the behavior of economic agents
Demand-pull inflation caused by increase in the AD.
Mechanism of the demand-pull inflation is following: M↑ AD↑ P↑
a) Short-run b) Long-run
P P2 P1
LRAS
AD2
AD1
E2
E1
Y* Y
P P2 P1
SRAS
AD2
AD1
E2
E1
Y1 Y2 Y
Cost-push inflation Cost-push inflation caused by an
increase in the cost of production and a decrease in the ASP↑ Cost of Production↑ AS↓
Reasons: Lower productivity an increase in the prices of imported
raw materials an increase in wages of officials dominated monopolism trade-union regulation of Labor market high indirect taxes
Cost-push inflation caused by an increase in the cost of production and a decrease in the ASMechanism of the cost-push inflation: P↑ Cost of Production↑ AS↓
P P2 P1
LRAS SRAS2
SRAS1
AD
E2
E1
Y2 Y* Y
Built – in inflation (“price – wage spiral”) Mechanism of the inflation spiral “price –
wage” M↑AD↑P↑W↑Cost↑SRAS↓P↑W↑AD↑P↑W↑C
ost↑SRAS↓P↑W↑ … and so on Inflation spiral means the situation, in which
inflation is caused by demand and supply factors. Action of one factor is determined by the action of previous counterpart factor.
Built – in inflation (“price – wage spiral”)
PP5
P4
P3
P2
P1
SRAS2
SRAS1
AD3
AD2
SRAS3
E5
E4
E3 E2
E1
Y
AD1
Mechanism of the inflation spiral “price – wage”M↑ AD↑ P↑ W↑ Cost↑ SRAS↓ P↑ W↑ AD↑ P↑ W↑ Cost↑ SRAS↓ P↑ W↑ … and so onInflation spiral means the situation, in which inflation is caused by demand and supply factors. Action of one factor is determined by the action of previous counterpart factor.
monetary factors (additional issue of Money, budget deficit, high velocity of money circulation, negative consequences of Government credit-monetary policy and so on)
economic-productive factors (high monopolism, changes in the cost of production, results of income policy of Government)
outside factors (import of inflation) psychological factors (rational and adaptive
expectations of business and consumers)
Determinants of inflation
CAUSES OF INFLATIONThere are different schools of thought as to what causes inflation. Quantity theory of Money. M. Friedman said “Inflation is always and everywhere a monetary phenomenon”. FISHER EQUATION:
PYMV
YMV
P
where: M – mass of money
P – general price level
V – velocity of money circulation
Y – real GDP3 reasons of raising prices:
M ↑(additional issue
of Money)
V ↑ Y ↓
major cause
Anti - inflationary Policy of Government
active policy adaptive policy
MAJOR GOALS
1. to limited negative consequences of inflation
1. to eliminate sources of inflation
2. to provide price stability
to prepare for anticipated inflation
MEASURES
Indexation of wages, pensions…
Compensation of losses
Supporting the well-being of population
Monetary :1)control over issue of M 2)control over lending ability of credit institutions (tools of tight credit-monetary policy) 3)nullification of monetary unit Non-monetary :1) Against Demand-pull inflation – Public expenditures –Tax rate– Budget deficit 2)Against Cost-push inflation: antimonopoly regulationintroduction advanced technologies (cost of Production ↓ , Production ↑ )wage and price controlsstructure policy of Government
Phillips curve and its transformation into stagflation curve (long-run)
(% per year)Stagflation curve
Phillips curve
U (% per year) U2 U3 U*
U*
AI
AII
A
B
C
D
1
2
3
*
The Phillips curve shows the trade off between inflation and unemployment.According to this view, a nation can buy a lower level of unemployment if it is willing to pay the price of a higher rate of inflation.
People can prepare for anticipated inflation by indexing incomes, benefits, loans. Rational economic agents can take anticipated inflation fully into account in their actions and decisions and protect themselves. Common consequences of anticipated and unanticipated inflation are following:
Purchasing power of money ↓
PPPM 1
, P – is price level
Inflation tax ↑
1
1
t
t
PMT .inf
“flight from money”
transaction cost ↑ (shoe-leather cost, menu cost, cost of relative price distortions, cost of confusion and inconvenience)
outflow of capital
investment and saving are discouraged