Inflation

What is Inflation?
https://www.youtube.com/watch?v=
UMAELCrJxt0
 Inflation
• Is any price increase defined as inflation?
• Can inflation take place without rising prices?
• Was inflation possible when money was gold?
• Is the growth of money supply always causing
inflation?
• Is any excessive supply of money always
causing inflation?
 In economics, inflation (‘to baloon’) is a
general rise in the price level in an economy
over a period of time

Inflation is a quantitative measure of the rate at

which the average price level of a basket of selected
goods and services in an economy increases over a
period of time.
In economics, inflation is a sustained increase in the
price level of goods and services in an economy over
a period of time due to the increase of money
supply.
 Inflation

decline of purchasing
power of a given
currency over time.
Classification of inflation basing on:
• Absolute vs relative
• Form of manifestation
• Cause
• Degree of control
• Level of anticipation
• Rate
• Localization
• Level of uniformity
 Gold standard - Coin counterfeiting:
Tendency of silver or gold coins to be "shaved”
(clipped), that is, to have small amounts shaved off
the edges of the coins by users, thereby reducing the
actual precious metal content of the coin. In order to
prevent this, silver and gold coins began to be
produced with milled edges.
Debasement is the practice of lowering the value of
currency. A coin is said to be debased if the quantity
of gold, silver, copper or nickel is reduced.
Composition of a penny was pure copper from 1793
to 1837, in 1982 - 97.5% zinc and 2.5% copper
Gold hoarding / withholding / immobilization

• Withholding of gold from circulation with the

aim of accumulation in the form of treasure,
but without
• Automatic regulation of money supply
 Form of manifestation
Based on comparison with:
• Goods / services
Open / suppressed
• Savings (induced)
• Foreign currency (devaluation)
 Open /hidden inflation
Product quality or quantity that decreases despite a
decrease in price. Hidden inflation occurs when
products remain at the same price, yet are offered in
lower numbers or lower quality.
 Induced savings in the USSR Commodity
stock for one ruble
1970 1990

Stock of money 73 568

Commodity 45 72

Commodity stock per 1 0,62 0,13

ruble
 Suppressed inflation
Inflation becomes suppressed or repressed when the
government and the monetary authorities do not
allow the prices to rise to a high level. Suppressed
inflation refers to the state of a set of markets or an
economy in which there is persistent excess demand
for goods and services. If prices are below their
market-clearing levels, demand will outweigh the
available supply; this should drive prices up, causing
Inflation. Features of markets suffering from
repressed inflation will thus be queues price-control-
cum-rationing and constant shortages and black
markets.
 Demand Pull inflation-
too much money is chasing too little goods
Cost-push inflation
 Cost-push inflation can be caused by many
factors
1. Rising wages
2. Rising import prices
3. Rising raw material prices
4. Profit push inflation
5. Declining productivity
6. Higher taxes
•
 Level of anticipation
• Planned (inflation targeting)
• Shock
• Anticipated:
self-fulfilling prophecy - a prediction that directly or
indirectly causes itself to become true, by the very
terms of the prophecy itself, due to positive
feedback between belief and behavior.
 Rate of inflation
Creeping: mild, when prices rise 3 % a year
or less.
Walking - strong, or pernicious, inflation is
between 3-10 % a year.
Galloping - when inflation rises to 10 %a
year or more, it wreaks absolute havoc on
the economy.
Hyperinflation - when prices skyrocket more
than 50 % a month.
24
A McDonald’s Menu from 1972
 The largest denomination banknote ever
officially issued for circulation was in 1946 by the
Hungarian National Bank for the amount of 100
quintillion pengő. The banknotes did not show
the numbers in full
In November 2008” estimate Zimbabwe's annual
inflation rate at 89.7 sextillion (1021) percent. The
highest monthly inflation rate of that period was 79.6
billion percent (7.96 × 1010%; 79,600,000,000%), and a
doubling time of 24.7 hours.
1993, Ukraine: 10 260%
In 2020 a person needed 14,6M Bolivar to buy
2,4 kg of chicken meat in Venezuela 2020
 Inflation goes in 3 stages.
1.People save their money, waiting for prices to fall.
When they hold onto their money the newly
printed money does not enter the market, and
prices do not rise very fast.
2.Money is changing hands faster. Prices are rising
faster than the money being printed.
3.Money is changing hands very fast, (because the it
has lost value) people try to get rid of money.
Prices are skyrocketing. When inflation reaches the
third stage, no one can stop the currency from
losing its value.
• Localization
local or global
imported inflation (may be caused by foreign
price increases or depreciation of a country's
exchange rate)
• Level of uniformity
Inflation that does not change the relative prices of goods
and services is called balanced.
Unbalanced inflation means that the relative prices of
goods and services alter. Unbalanced inflation changes the
equilibrium situation at the markets.
 Measurement of inflation
The most common price indexes are:
Consumer price index (CPI),
Wholesale price index (WPI)
Producer Price Index (PPI) and
Implicit price deflator (GDP deflator).
.
38
 PPI – Producer Price Index
PPI monitors average prices relating to producers.
There are three PPI indexes. One index includes
the prices of raw materials, the second covers
intermediate goods prices and the third includes
final products. These three PPI indexes focus
mainly on producer prices of heavy industry,
manufacturing industry and agriculture. In the long
term, CPI and PPI reflect the same rate of
inflation. In the short term, PPI increases earlier
than CPI, because it takes some time before the
increase in producer prices will be reflected in the
prices paid by consumers.
 GDP Deflator
This price index covers all output. Unlike the CPI and
PPI, GDP deflator is not based on a fixed basket of
goods and services. GDP deflator enables a change of
basket varied according to the patterns of consumption
and investment. Its value reflects both price changes
and market response to these price changes, reflected
the new model costs.
 Perception of inflation
• Money does not matter
• Quantity theory: Much money is evil
• John Maynard Keynes: a rise in the price level will
help expansion of income, output and
employment (as long as there are unemployed
resources)
• Milton Friedman: “inflation is always and
everywhere a monetary phenomenon”
• Aim of the monetary policy of the most developed
countries – inflation targeting
 Speech of Rudolf Havenstein, the head
of the Reichsbank, in August 1923
The wholly extraordinary depreciation of the mark has
naturally created a rapidly increasing demand for
additional currency, which the Reichsbank has not always
been able fully to satisfy. A simplified production of notes
of large denominations enabled us to bring ever greater
amounts into circulation. But these enormous sums are
barely adequate to cover the vastly increased demand for
the means of payment, which has just recently attained an
absolutely fantastic level, especially as a result of the
extraordinary increases in wages and salaries.
In July 1914, the German mark had been worth
25 cents. By November 1923 it took 4.2 trillion marks to
purchase $1
 Economic essence
• by printing new money to finance its deficits, the
government and the early receivers of the new
money benefit at the expense of those who receive
the new money last or not at all:
• Inflationary increases of the money supply are
pernicious forms of tax because they are covert,
and few people are able to understand why prices
are rising. Direct, overt taxation raises hackles and
can cause revolution; inflationary increases of the
money supply can fool the public— its victims—for
centuries.
 Supply-side policies
• Supply-side policies aim to increase long term
competitiveness and productivity. For example, it
was hoped that privatization and deregulation
would make firms more productive and
competitive. Therefore, in the long run, supply-side
policies can help reduce inflationary pressures.
• However, supply-side policies work very much in
the long term; they cannot be used to reduce
sudden increases in the inflation rate. Also, there is
no guarantee government supply-side policies will
be successful in reducing inflation
 INFLATION: PROS AND CONS
PROS CONS
❑ Moderate inflation ❑ Creates uncertainty and
enables economic lower investment. Reduces
growth. international
❑ Moderate inflation competitiveness.
allows adjustment of ❑ Causes fall in value of
real wages. savings.
❑ Moderate inflation ❑ High inflation often leads
allows adjustment of to lower growth and less
prices. stability.
❑ Moderate inflation ❑ Hyperinflation can destroy 50
reduces the real value the economy.
of debt.
 Inflation control in Venezuela
In 2013 Venezuela jailed 100 'bourgeois'
businessmen in crackdown on alleged price-
gouging at hundreds of shops and companies.
Soldiers and inspectors have gone into 1 400
shops, taken over operations at an electronics
firm and a battery-making company. They were
sold at 10 percent of their price.
“They are barbaric, these capitalist parasites!”
 Deflation
• Creditors become more conservative, and slow their
lending.
• Potential debtors become more conservative, and
borrow less or not at all.
• Investors become more conservative, they commit less
money to debt investments.
• Producers become more conservative and reduce
expansion plans.
• Consumers become more conservative, and save more
and spend less.
.
Deflationary Spiral is a downward price reaction to an
economic crisis leading to lower production, lower
wages, decreased demand and still lower prices. 
Md: As the value of the currency relative to the goods increase,
people have the incentive to hoard the currency: by merely holding
it, they hope to be able to purchase more goods for less money in
the future. A lack of currency available in the market causes the
price of goods to further decrease, resulting in more hoarding.
Ms: Deflation increases the real value of debt. This makes it
harder to meet repayments and companies are more at risk of
going bankrupt. Because bankruptcies increase, banks become
reluctant to lend. This leads to a further fall in spending and
investment.
Such a spiral amounts to a vicious circle, where a chain of events
reinforces an initial problem.
Deflation spiral
 DEFLATION: PROS AND CONS
PROS CONS
❏ In theory, can lower the ❑ Falling prices discourage
price level and increase consumer spending
real GDP. ❑ Increases the real value of
❏ In theory, if one country money and debt
has deflation, and others ❑ Increases real interest
have inflation, that rates which can’t fall
country will become more below zero
internationally ❑ Causes real wages to rise
competitive, leading to a causing real wage
rise in exports. unemployment. 62
 Phillips curve
William Phillips wrote a paper in 1958 titled The
Relation between Unemployment and the Rate of
Change of Money Wage Rates in the United Kingdom,
1861-1957.
The Phillips curve is a single-equation econometric
model, named after William Phillips, describing a
historical inverse relationship between rates of
unemployment and corresponding rates of rises in
wages that result within an economy. Stated simply,
decreased unemployment, (i.e., increased levels of
employment) in an economy will correlate with higher
rates of wage rises.
 The Phillips curve
a historical inverse relationship between rates of
unemployment and corresponding rates of rises in
wages.
 Sequence of responses
1.An increase in the demand for labour as
government spending generates growth.
2.The pool of unemployed will fall.
3.Firms must compete for fewer workers by raising
nominal wages.
4.Workers have greater bargaining power to seek out
increases in nominal wages.
5.Wage costs will rise.
6.Faced with rising wage costs, firms pass on these
cost increases in higher prices.
Stagflation and Phillips Curve
 There are no easy solutions to stagflation.
• Monetary policy can generally try to reduce inflation
(higher interest rates) or increase economic growth (cut
interest rates). Monetary policy cannot solve both
inflation and recession at the same time.
• One solution to make the economy less vulnerable to
stagflation is to reduce the economies dependency on oil.
Rising oil prices are the major cause of stagflation.
• The only real solution is supply-side policies to increase
productivity, this enables higher growth without inflation.
In 2010/11, the Central Bank decided to keep interest
rates low (at 0.5%) because they felt low growth was a
bigger problem than some temporary cost-push inflation.
 Hometask

Anti-inflationary policy