INFLATION

Measurements of Inflation

https://www.tuc.org.uk/blogs/inflation-measures-arent-boring-they-matter
RPI v CPI
Definition: Inflation; Deflation; Disinflation
A fall in the rate of
• Inflation inflation

• Deflation A persistent rise in the

general level of prices
• Disinflation
A persistent fall in the
general level of prices
Definition: Inflation; Deflation; Disinflation
A fall in the rate of
• Inflation inflation

• Deflation A persistent rise in the

general level of prices
• Disinflation
A persistent fall in the
general level of prices
Definition: Inflation; Deflation; Disinflation
A persistent rise in the
• Inflation general level of prices

• Deflation A persistent fall in the

general level of prices
• Disinflation
A fall in the rate of
inflation
 Good Examples of Inflation, Deflation and
Disinflation in Japan 1990-2011

Identify examples of data showing inflation, disinflation and deflation in Japan 1990-2011
 Causes of Inflation and Deflation
• There are two main causes of inflation:
– Demand Pull inflation (caused by rising AD)
– Cost Push inflation (caused by falling AS)
• There are two main causes of deflation
– Demand side (caused by a fall in demand)
– Supply side (caused by an increase in supply)
 The Causes of Inflation
https://www.youtube.com/watch?v=USj52Vlvd5M

• Demand-Pull • Cost-Push

AD shifts right AS shifts left

AD > AS at P AS < AD at P
Excess demand at P pushes up prices to P1 Excess demand at P pushes up prices to P1
What might have caused this? What might have caused this?
Expansion or contraction of GDP? Problem? Expansion or contraction of GDP? Problem?
 DEMAND PULL INFLATION
• Remember that AD=C+I+G+(X-M)
• Any increase in AD could be
inflationary*
• This is known as demand-pull
inflation
• Is it a problem, given that national
output is increasing?
– Depends on how much and
predictability of the inflation rate
– Depends on economic cycle: POG or
NOG
– Depends on the flexibility of AS
(supply-side factors) and whether
inflationary pressure can be reduced
– So, plenty of dependent factors to
help you achieve the skill of…..
 COST PUSH INFLATION
• This is caused by an increase in
the costs of production which
reduces AS
• Higher costs – eg rising oil price
– will shift AS to the left. Other
key factors:
– Productivity ↓
– Wage growth ↑
– ER↓
• Does it matter?
– Probably ‘Yes’ as national output
could be falling
– Could contribute to Stagflation
 Quantity Theory of Money

“Inflation is always and

everywhere a monetary
phenomenon”
Milton Friedman
(1912 – 2006)
Nobel Prize 1976
 Quantity Theory of Money:
Fisher Equation

How much money is there on earth?

https://www.youtube.com/watch?v=w2tKg3E53DM
 Effects of Expectations
 Assume inflation is currently 2%
 If expectations are that inflation will rise to
4%, then wage demands will be for at least a
4% pay rise
 If wage demands are successful this increases
costs for firms, leading to cost-push inflation
 This is why the inflation target is so important,
in order to moderate inflationary expectations
OK, so what about Deflation?
 Causes of Deflation
• Benign (Harmless) • Malign (Harmful)

Compare and contrast the impact on national output and employment, but also on less
measureable factors such as confidence, expectations, investment etc
The Consequences of Inflation
and Deflation
 So, how much does inflation or deflation
matter?
• Depends on:
– The root cause: benign or malevolent?
– The rate of price changes, (in relation to the inflation
target) degree of volatility and duration
– The type:
• Eg. On Target, Creeping or Hyperinflation
– How much it is expected or anticipated
– How much confidence there is that the authorities will
deal with the problem
– Whether or not this is an ‘international’ scenario or
domestic problem
 Consequences of Inflation/Deflation
• How does inflation/deflation impact on all stakeholders in the economy?
– Individuals
• Consumers
• Employees
• Savers
• Borrowers Make notes on all
– Firms possible consequences of
• Producers inflation/deflation and
• Lenders aim to judge significance.
• Exporters Also, introduce examples
– Economy and diagrams where
• Trade balance
possible.
• Employment
• Living standards
• Trade Unions
– The Government
• Target setters and policy makers
– The Central Bank
• Implementation of monetary policy
• Consider SR v LR arguments
• Which is worse: inflation or deflation? Justify a response.
 Which of these statements are true?
• Inflation is a rise in prices
• Prices are currently higher on average in Venezuela than in the
USA
• Inflation is caused mainly by demand factors
• There is only one way to measure inflation
• Inflation is controlled by the central bank, not the government
• Inflation can be imported from other countries
• Disinflation means prices are rising quicker than before
• Stagflation is caused by a disease affecting deer and other
mammals that are traditionally hunted
• Inflation is worse than deflation
 A Brief History of Inflation
• https://www.youtube.com/watch?v=w2tKg3E53DM How
money is there on earth?
• https://www.youtube.com/watch?v=7rpvxZphZZc Brief
history of inflation (BOE)
• http://
www.bankofengland.co.uk/education/Pages/resources/infla
tiontools/calculator/flash/default.aspx
Inflation Calculator
• http://
www.thisismoney.co.uk/money/bills/article-1633409/Histori
c-inflation-calculator-value-money-changed-1900.html
• https://www.youtube.com/watch?v=T8-85cZRI9o Crash
Course Inflation
 What you need to know about Inflation
• Definitions of Inflation, Deflation and Disinflation
• Measurement of inflation and associated problems (CPI/RPI)
• The causes and consequences of inflation
• The causes and consequences of deflation
• The implications for government policy
• AD/AS Diagrams
• Data examples
• Also:
– How a weighted Consumer Price Index (CPI) is calculated
– The relationship between inflation and unemployment