Economic issues ofthe day: Inflation

UNIT 1:The Concept of

Inflation

InflationInflation: a sustained rise in the general level of prices of goods and service over a period of time.

Erodes the purchasing power of consumers.

Calculation using a price index. • CPI• PPI

Measures of InflationCPI: measures changes in consumer prices. Headline rate of inflation.

CPIX: CPI - interest rates on mortgage bonds.

PPI: consists of a ‘basket’ of local, exported and imported goods.

Shortcomings of price indices

• No ‘average household’ • Selection of goods/services not always

representative of entire population. • Weighting may not be accurate • Random sampling may not represent

population as a whole.

UNIT 2:Types and

characteristics of inflation

Demand-Pull InflationDemand-pull inflation: total demand for goods and services exceeds total supply.

Cost-push inflationCost-push inflation: due to increases in the costs of factors of production, such wages & raw materials.

StagflationStagflation: persistent high inflation, a slowing economic growth rate and high unemployment.

Difficult for economic policy because:• to lower inflation (↑ IR’s) → higher

unemployment• increasing employment → higher inflation

HyperinflationHyperinflation: extravagant and unrestrained general price increases in excess of 50% per month.

650 million googol per cent6,5 × 10 108 per cent or 65 followed by 107 zeros

government creates money to pay for its

expenses

currency loses its real value very quickly

prices increase dramatically

people quickly spend whatever they receive as

the value decreases

causes further acceleration in

prices.

UNIT 3:Causes and

consequences of inflation

Causes of demand-pull inflation

Cause by factors that ↑ C, I, G (X-M)

Moneterists: ↑ in money supply main cause

Keynsians: Inability of increase output to meet the increased demand

Causes of cost-push inflation

Caused by increase in…• Imported raw materials and capital equipment

(weak rand)• price of oil • Increased labour costs (wage increases >

productivity increases• Rise in interest rates • Increase in taxes

The consequences of inflationNegative impact on economic growth.Discourages savings & investments

Real value of money and savings decreases5% interest - 8% inflation rate = real rate of interest of –3%.

Balance of paymentsPrices of exported goods increase & imported goods decreaseLoss of export competitiveness → unemployment.

Redistribution of income in a countryLow-income groups more affected • No assets that to rise faster than inflation• poor wage bargaining power

Causes further inflationHigher wage demands cause producers to increase their prices to maintain their profits…

UNIT 4:The inflation problem

in South Africa and measures to combat

inflation

Problems…Volatility of inflation not good for investment

Higher than EU & USA therefore SA’s prices rise faster than trading partners ↓ competitiveness.

Measures to combat inflation

Dealing with demand-pull inflation

Restrictive fiscal policy ↑ taxes ↓ gov spending

Restrictive monetary policy ↑ interest rates

Dealing with cost-push inflation• compulsory measures to contain wage and

price increases.• polices aimed at increasing productivity

– tax rebates/subsidies for workplace education & technology.

Inflation targetingAdopted in 2000 Inflation target set MPC (Gill and Pravin)3% - 6%SARB committed to achieve thisPolicy instrument = repo rateMPC meets every 3 months – public

informationAccountable to parliament