TOPIC 2C

Inflation Vs Deflation
Debate
 Inflation

Should it be zero or
+ve or
-ve?
Jan 2012-2014
 Inflation
Inflation refers to a
sustained increase in the
average level of prices
Inflation
Disinflation is a reduction in the positive
inflation rate, e.g. Europe, USA in 1980s in
India in the late 1990s,
Deflation is a sustained decrease in the
price level (a negative inflation rate), e.g.
Japan in 1990s, USA in 1930s
Hyperinflation is a very high rate of inflation
Brazil experienced inflation over 1000% during
1970s & 1980s, Germany between WW1 and
WW2, Hungry after WW1 periods.
 Hyperinflation
Hyperinflation is a very high rate of inflation
Case Study:Germany between WW1 and WW2.
For e.g. Price of newspaper rose from 0.3 marks
in January 1922 to 1 mark in May 1922 to 8
marks in October 1922 to 100 marks in fall of
1923, to 1000 marks in September 1923. Then
in end 1923 prices took off 2000 marks Oct 1 to
20000 marks on Oct 15 to 1 million marks Oct
29 to 15 million on Nov 9 to 70 million on Nov
17.
In Dec everything suddenly stabilised
 Hyperinflation
Hyperinflation
When inflation per month crosses 30
percent.
Israel, Hungry, Mexico, Argentina, Brazil,
Chile, Russia, Zimbabwe
To keep Friends do not lend/borrow in
times of hyperinflation
 End Avg. Avg
Price/Initial Monthly Monthly
Beginning End Price Inflation Money
Austria 01/10/21 01/08/22 70 47 31
Germany 01/08/22 01/11/23 1x10+10 322 314
Greece 01/11/43 01/11/44 4.7x10+6 365 220
Hungary I 01/03/23 01/02/24 44 46 33
Hungary II 01/08/45 01/07/46 3.8x10+27 19,800 12,200
Poland 01/01/23 01/01/24 699 82 72
Russia 01/12/21 01/01/24 1.2x10+5 57 49
Inflation and Interest Rates
Inflation creates a difference between
real and nominal interest rates
The nominal rate of interest is expressed in current rupees
as a %age of the amount loaned, common
The real interest rate is expressed in Rupees of constant
purchasing power as a %age of the amount loaded

Inflation risk forces lenders (FIs) offer

adjustable-rate loans
(e.g. Housing n Car Loans etc.)
 Types of Inflation
Demand Pull Inflation
Cost Push Inflation
wage (or input price) push
profit push
Demand-Pull Inflation

AD AD AS A sustained rise
in the price
level caused by
increases in
aggregate
demand
Aggregate Output
Cost-Push Inflation:
Wage or Profit Push
A sustained rise in the
price level caused by
AD AS AS reductions in
aggregate supply
The combination of
inflation and a falling
level of output has
come to be called
stagflation
Aggregate Output
Anticipated Versus Unanticipated
Inflation
A major issue is whether
workers can accurately
anticipate changes in the price
level
Workers seek to anticipate
inflation so that the purchasing
power of wage contracts is
maintained
The extent to which workers
can anticipate inflation
determines the effects of
inflation on them in the
economy
Why is Inflation So Unpopular?
As an economic problem, inflation is
widespread
Workers wages rarely keep up with
inflation (real wages fall)
Those on fixed incomes are seriously
affected (pensioners)
Long-term contracts are difficult to
negotiate (Fixed interest loans etc.)
Disinflation
4 Reduction in inflation slower increases in
prices (say from 13% to 10%)

Deflation
4 Negative inflation falling prices [say
from 5% to (-)2%]
Problem with deflation?

Price uncertainty profits fall

High real interest rates

Real burden of debt

goes up (Debt-
Deflation Spiral)
Inflation & Output Link
4 high inflation faster increases in prices
if it leads to higher profits then the
output will rise and subsequently inflation
could fall

Deflation & Growth

4 Negative inflation > falling prices
falling profits -> output will fall
leading to recession
z Link between Stock Market
and Inflation & Interest Rate
z Link between Exchange Rate
and Interest Rate (later)
 1990s
&
2000s

1970s
&
1980s