CHAPTER

INFLATION

Lecturer: Assoc. Prof., Ph.D. DANG VAN DAN

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 CONTENTS

1. DEFINITION OF INFLATION

2. MEASURES OF INFLATION

3. CLASSIFICATION OF INFLATION

4. CAUSES OF INFLATION

5. IMPACTS OF INFLATION

6. SOLUTIONS TO CONTROL INFLATION

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1. DEFINITION OF INFLATION

1.1. PERSPECTIVE OF K.MARX

Inflation is a phenomenon

where banknotes overflow

the monetary circulation

channels, exceed the needs of

the real economy, devalues

the currency, and

redistributes the national

income.
Hyperinflation in Hungary in 1946
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1. DEFINITION OF INFLATION

1.2. MODERN PERSPECTIVE

Inflation is a phenomenon that occurs when the general

price level in the economy rises for a certain period of time.

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2. MEASURES OF INFLATION

2.1. CONSUMER PRICE INDEX (CPI)

✓ CPI (Consumer Price Index) is an index capturing the
average price calculated by a basket of major goods and
services in the market, using a certain weight for each item.
✓ Formula for determining inflation by CPI

Consumer price index in year t

CPIt − CPIt −1
Π e
CPI(t) = .100
CPIt −1

Inflation rate in year t Consumer price index in year (t-1)5

2. MEASURES OF INFLATION

2.2. PRODUCER PRICE INDEX (PPI)

✓ Producer Price Index (PPI) measures the average price of
a basket of goods in production, reflecting the average
cost of production in the society.
✓ The inflation rate according to PPI is calculated in the
same way as CPI, but the quantity of goods in PPI is more
than that of CPI and the price in PPI is based on the
wholesale price.

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2. MEASURES OF INFLATION

2.3. GDP PRICE DEFLATOR (PGDP)

✓ The GDP price deflator (PGDP), also known as the GDP
deflator or the implicit price deflator, measures the changes
in prices for all of the goods and services produced in an
economy.
✓ PGDP in period t is defined as:

Nominal GDP

GDPd
PGDP(t) = .100 Real GDP

GDPt
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2. MEASURES OF INFLATION

2.3. GDP PRICE DEFLATOR (PGDP)

✓ Inflation under PGDP is defined as:

GDP deflator in year t

Inflation rate in year t

PGDP(t) − PGDP(t-1)
Π e
PGDP (t) = .100
PGDP(t-1)

GDP deflator in year (t-1) 8

3. CLASSIFICATION OF INFLATION

3.1. MODERATE INFLATION

✓ Moderate inflation occurs when commodity prices rise

slowly and predictably, and the inflation rate (in percentage)

is usually less than one digit.

✓ Signals:

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3. CLASSIFICATION OF INFLATION

3.1. MODERATE INFLATION

Period of moderate inflation in Vietnam

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3. CLASSIFICATION OF INFLATION

3.2. HIGH INFLATION

✓ High inflation occurs when commodity prices rise rapidly,

the inflation rate (in percentage) usually varies from 2 to 3

digits per year.

✓ Signals:

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3. CLASSIFICATION OF INFLATION

3.2. HIGH INFLATION Period of high inflation in Vietnam

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3. CLASSIFICATION OF INFLATION

3.3. HYPERINFLATION
✓ Hyperinflation occurs when commodity prices rise
extremely fast at a rate of 4 digits or more per year.
✓ Signals:

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2. CLASSIFICATION OF INFLATION

3.3. HYPERINFLATION
(*) 5 cases of highest hyperinflation in the world history

Time to price
Country Time Highest inflation rate
doubled

Greece 10/1944 13.800 % 4,3 days

Germany 10/1923 29.500 % 3,7 days

Yugoslavia 01/1994 315.000.000 % 1,4 days

Zimbabwe 11/2008 79.600.000.000 % 24,7 hours

Hungary 06/1946 13.600.000.000.000 % 15,6 hours

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4. CAUSES OF INFLATION

4.1. DEMAND-PULL INFLATION

AS
Price
E1
Price increases

P1
E0
P0 AD1

Aggregate
demand
AD0 increases
0
Q0 Q1 Quantity 15
4. CAUSES OF INFLATION

4.1. DEMAND-PULL INFLATION

SPECIFIC CAUSES

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4. CAUSES OF INFLATION

4.2. COST-PUSH INFLATION

Price AS1 Aggregate supply decreases

E1 AS0
Price increases

P1
E0
P0

AD

0
Q1 Q0 Quantity 17
4. CAUSES OF INFLATION

4.2. COST-PUSH INFLATION

SPECIFIC CAUSES

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5. IMPACTS OF INFLATION

5.1. IMPACTS ON NOMINAL INTEREST RATES

Rate S1
E2 1. Capital supply
i2 decreases
S0
Rate increases

E1
i1
D1
E0
i0
2. Capital demand
increases
D0

0
Q1 Q0 Q2 Capital 19
5. IMPACTS OF INFLATION

5.2. IMPACTS ON REAL INCOME

Unforeseeable inflation often results in a redistribution of

national income: the wages of workers decline, and lenders

generally suffer from declines in real interest rates.

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5. IMPACTS OF INFLATION

5.3. IMPACTS ON INVESTMENT

Moderate inflation can lead to credit expansion and

investment stimulation, thus boosting economic

development. But high inflation has the opposite effect.

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5. IMPACTS OF INFLATION

5.4. IMPACTS ON UNEMPLOYMENT

Inflation
Short Run Phillips Curve

2 E2

E0
0
E1
1
SRPC

0 Unemployment
U2 U0 U1 22
5. IMPACTS OF INFLATION

5.5. IMPACTS ON FOREIGN DEBTS

✓ Each economy has a certain level of foreign debts

✓ Inflation → domestic currency depreciates against foreign

currency → exchange rate rises → increasing the burden of

foreign debts.

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6. SOLUTIONS TO CONTROL INFLATION

6.1. MONEY SUPPLY TIGHTENING

Monetary policy restriction

Fiscal policy restriction

Limited income policy

Limited labor policy

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6. SOLUTIONS TO CONTROL INFLATION

6.2. EXTENDING MONEY DEMAND

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