Inflation

Learning Unit 9

Chapter 20: The Whole Chapter

Economics for South African Students

Phillip Mohr and associates
Principles of Macroeconomics Workbook
IIE
 Inflation

A continuous and considerable rise in prices in general.

Note the important points regarding inflation on pg 382

• The definition is neutral

• Continuous
• Considerable
• Prices in general

What about deflation??? Is that good?

Figure 1

Figure 2

Figure 3
 The Measurement of Inflation:
Inflation is measured using the CPI.

The CPI measures the prices of a representative basket of goods and services

We can calculate the CPI in two ways:

1. Month on same month during the previous year.
2. Annual average on annual average

Look at examples in the textbook on page 426 – 427 of how to

calculate these two:
There are many different inflation indicators:

• Headline Inflation
• Core Inflation
• The CPIX
• The Producer Price Index
• The Implicit GDP deflator
 Headline Inflation
This is what is announced on the news.

It is the CPI of all urban areas.

 Core Inflation
This is calculated by Stats SA in order to establish the
underlying causes of inflation.

Core inflation = CPI – any goods and services that:

• Have highly volatile prices

• Have prices that are subject to temporary influences
• Have prices that are subject to Government intervention
The following items are therefore removed from Core Inflation:
Fresh & frozen meat and fish
Fresh and frozen fruit, nuts and vegetables
Interest rates on mortgages, VAT and Assessment rates
 The CPIX
This has been used since SA started Inflation
Targeting.

In SA the inflation target is between 3 – 6%.

The CPIX = CPI – interest rates

This is because interest rates are the main tool of

monetary policy.
 The Producer Price Index
• The PPI measures prices at the first significant
commercial transaction.
• It therefore measures the cost of production.

• This means that manufactured goods are

measured as they leave the factory, unlike
consumer goods which are measured when
they are sold to consumers.
The main difference between the CPI and PPI can
be shown as follows:
The CPI The PPI
• Cost of Living • Cost of producing
• Basket = Consumer goods • Basket = Goods only (no
and services services)
• Capital & Intermediate • Capital & intermediate
goods excluded goods included
• Prices include VAT • Prices exclude VAT
• Interest rates included • Interest rates excluded
• Prices of imported goods • Prices of imported goods
not explicitly shown shown explicitly

The PPI is very important, because it predicts what will happen to the
 The Implicit GDP deflator
This uses another calculation to calculate inflation. Ie)
remember what the difference between nominal and
real GDP is.

Nominal GDP uses __________ prices and therefore

contains inflation whereas Real GDP uses
_____________ prices and eliminates the effect of
inflation.

Thus Nominal GDP – Real GDP gives us inflation.

 The Effects of Inflation
Inflation should be controlled at all costs
because it has the following effects on society:

• Distribution Effects
• Economic Effects
• Social and Political Effects
• Expectations of Inflation
 Distribution Effects
• Benefits debtors at the expense of creditors.

• Redistributes income and wealth from the old to the

young.

• It can redistribute from the private sector to the

government.

• The Gov can also gain through the tax system ie

bracket creep.
 Economic Effects
• The efforts of entrepreneurs could be directed away from
innovating and production.

• It can lead to speculative practices (ie investing in art,

property etc instead of investing in new production.

• It reduces savings because the consumers feel that their

savings lose value at times of high inflation.

• It can lead to BOP _____________, because when

inflation is very high in SA it reduces our ____________
and increases our ______________.
 Social & Political Effects
Inflation can give rise to social and political
unrest.
 Expectations of Inflation
This is perhaps the greatest cost.

If people think that inflation is about to occur,

they behave in such a way that they make it
occur.
 Causes of Inflation
Since inflation is such a bad social evil, it is
important to understand what is causing it, so that
we can use the right tools to fix it.

We distinguish between 2 main causes of

inflation:

• Demand Pull Inflation

• Cost Push (Supply Shock inflation)
 Demand Pull Inflation
Caused By: Too much spending. C + I + G + X
It has been described as too much money chasing too few goods.
P
AS
You must be able to draw Fig 20.1

Eo
Po

AD
Yo Y
Explanation of the Graph: Demand Pull is shown by a rightward shift of the
demand curve. This leads to a rise in prices and output until Yf is reached. At
that point the economy is at Full Employment. This means production can no
longer increase and only prices will increase.

Government Solution: Demand Management tools. You must be able to

describe Contractionary Monetary and Fiscal policy and show how it works.
Cost Push Inflation (Supply Shock)
Caused By: Increases in wages, increases in the costs of imported goods,
increases in profit margins, Natural Disasters and decreases in productivity.
P
AS

You must be able to draw Fig 20.2 Eo

Po

AD
Yo Y
Explanation of the Graph: Cost Push is shown by a leftward shift of the
supply curve. This causes an increase in Price and a decrease in output. This
can also be called stagflation.

Government Solution: Supply side measures, like Incomes Policy. You must
be able to understand why contractionary and expansionary policy cannot be
used.
 Anti-inflation Policy
• Incomes Policy Steps need to be taken to reduce
production costs. For wages to be reduced, it
must appear equitable to all parties involved.

• Indexation Prices, wages, pensions etc are linked

to changes in the CPI. This does not stop inflation
but it reduces the effect of it.

• Inflation Targeting This aims to use Policy

measures to keep inflation between 3 – 6%.
 The 5 key features of Inflation Targeting
are:
1. The announcement of quantitative targets. In SA this target
is__________
2. The primacy of price stability as the objective of monetary
policy.
3. A broad-based pragmatic approach to the analysis of inflation.
4. Transparency. The SARB must regularly inform the public of
its plans & objectives.
5. Accountability by the SARB.

Look at the advantages and disadvantages of inflation targeting on

pg 441
 Test Yourself
1) Explain, with the aid of a diagram, what measures a
Govt. should take to deal with demand-pull inflation
and restore price stability.
 Picture References:
Slide 3 Figure 1: Zimbabwe knocks 10 zeros off its currency amid world’s highest

inflation.
The Guardian
31 July 2008
Figure 2 and 3: Starving Billionaire
mhseco2016.worldpress.com
April 25, 2016