Inflation Inflation Rate Price Indexes Demand-Pull Inflation Cost-Push Inflation Upward Spiral of Prices and Wages Impacts of Inflation

Inflation

Inflation denotes a rise in the general level of prices.

The overall price level is measured by price indexes.

Deflation and Disinflation

Deflation occurs when the general level of prices is falling. Deflation have been rare in the late twentieth century.

Disinflation denotes a decline in the rate of inflation.

Price Index

A price index is a weighted average of the prices of a number of goods and services. Each price is weighted according to the economic importance of the commodity in question.

Price Index CPI –Consumer Price Index measures

the cost of a market basket of consumer goods and services, including prices of separate classes of commodities.

PPI – Producer Price Index measures the level of prices at the wholesale or producer stage.

GDP Deflator (IPD implicit price deflator) is the ratio of nominal GDP to real GDP and can thus be interpreted as the price index of all components of GDP.

Price Index CLI –Cost of Living Index measures the cost of

a market basket maintaining a certain standard of living.

The Price Index of Agricultural producers is calculated from prices collected among selected producers in agriculture (private, cooperative and state-owned companies) and does not include VAT.

Import and Export Price Indexes measure average changes in prices of goods and services that are imported or exported.

Inflation Rate Inflation rate (π) is the rate of change of

general price level measured e.g. by CPI:

t = given year

100

1

1

t

ttt CPI

CPICPI

Three Categories of Inflation Moderate Inflation is characterized by

slowly rising prices (single-digit annual inflation rate).

Galloping Inflation: inflation in the double- or triple-digit range.

Hyperinflation occurs when prices rise at a thousands, million or trillion percent annually.

Inflation

From the visibility point of view: Open Inflation Hidden Inflation Stifled Inflation

Inertial Inflation

Inertial Inflation is the rate of inflation that is expected and built into contracts and informal arrangements.

This built-in inertial inflation rate tends to persist until a shock causes it to move up or down.

Demand –Pull Inflation Demand-pull inflation occurs when AD

rises more rapidly than the economy’s productive potential.

Demand-pull inflation can arise from: High supply of money Excessive fiscal deficits

Demand –Pull Inflation

AD

AD1

AS

QP Q1

E

E1

P

P1

With a steep AS curve,much of the higher aggregate spending endsup in higher prices.

Q

P

Cost –Push Inflation

Cost-push inflation is resulting from rising costs during periods of high unemployment.

Cost-push inflation is a new phenomenon of modern industrial economies.

Cost –Push Inflation

AD

AS1 AS

QP Q1

E

E1

P

P1

Cost-push pressures dominate when labour unions exercise market power by rising wages, or when external factors drive up prices of raw materials unexpectedly.

Q

P

Upward Spiral of Prices and Wages

An upward spiral of prices and wages occurs when aggregate supply and demand shift up together. When prices and wages are rising and are expected to continue doing so, businesses and workers tend to build the rate of inflation into their price and wage decisions.

Upward Spiral of Prices and Wages

ADAD1

AS

QP

E

E1

Q

P

E2

AD2

AS1

AS2

Inertial inflation occurswhen the AS and AD curves are movingsteadily upward atthe same rate.

Slumpflation

AD

AS

QP

E

E1

Q

P

AS1

P

P1

P2

Q1

As long as inertial elementsdriving up costs arepowerful, a recession mayoccur simultaneouslywith high inflation.

Effects of Inflation Microeconomic effects of inflation on

income and wealth distribution Consumers and investors change their habits

(redistribution of expenditures) Income redistribution - people with fixed

income are less able to cope with inflation Wealth redistribution – in general, those who

have borrowed money are better off and it hurts those who have lent money.

Effects of Inflation Macroeconomic effects of inflation

Consumption structure changes, investment decisions became more complicated → total output falls

Substitution of labour for capital (if wages are growing faster than productivity) → structural unemployment increases

Exchange rate fluctuation , export is more expensive, domestic currency depreciates → prices of imported goods are growing . Final effect of depreciations depends on price elasticity of imported and exported goods.

Effects on output and economic efficiency - inflation may be associated with either a higher or lower level of output and employment;

There is no effect on real output, efficiency, or income distribution of an inflation that is both balanced and anticipated.

Anti-Inlationary Policy Fiscal policy, monetary policy and supply-

side policy. Government and Central bank anti-

inflationary measures: Decrease of budget deficit Loan restriction Price and wage freeze