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
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