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How could inflation affect you both short term and long term?
Causes and Consequences of Inflation
CHAPTER 13.3
Inflation Inflation--defined two ways
sustained rise in the level of prices generally
sustained fall in the purchasing power of money
Since 1960s, inflation has had significant impact on U.S. economy:
limited stock market growth, increased agricultural bankruptcies
For individuals and economy as a whole reduced purchasing power of the dollar
raised interest rates
Consumer Price Index
Consumer price index (CPI) measures changes in prices of products
U.S. government surveys people to learn what they buy regularly
creates a "market basket" of about 400 typical products
each month researches current prices of these items
compares prices to reference base, years 1982 to 1984
Producer Price Index
Producer price index (PPI) measures changes in wholesale prices
reflects prices producers get for goods; tied to a reference base
Over 10,000 PPIs for individual products and groups of products
Inflation rate--rate of change in prices over a set period of time
PPI tends to lead CPI as indicator of inflation
Types of Inflation Moderate rate of inflation--between 1 and 3
percent per year
Creeping inflation--moderate inflation over a period of time
Galloping inflation--rapid increase
Hyperinflation--over 50 percent per month
Deflation--decrease in general price level; happens rarely
What causes inflation?
Demand-pull inflation--total demand rises faster than production
If total demand rises faster than production, it creates scarcity
during lag period, demand pushes up prices for available products
Too much money printed during lag period will drive prices up
Cost-push inflation--increases in production costs push up prices
When production costs increase, producers make less profit
if demand is strong, may raise prices to maintain profits
Cost-push inflation may be due to higher price of materials, energy
Wages can be large part of production costs; wage-price spiral:
higher wages lead to higher costs, which lead to higher prices, which lead to higher wages
Effects of Inflation EFFECT 1: Decreasing Value of the Dollar
Rising consumer price index represents declining value of the dollar
People on a fixed income are especially vulnerable
each dollar they have buys less every year
Inflation helps people who borrow at a fixed rate of interest
pay debts with dollars that are worth less, so repayments are smaller
Effects of Inflation EFFECT 2: Increasing Interest Rates
Lenders raise interest rates to ensure profit on loans
Businesses avoid borrowing to expand or make capital improvements
Consumers less likely to finance high-priced items
Monthly credit card payments go up as rates rise
Effects of Inflation EFFECT 3: Decreasing Real Returns on
Savings
Interest on savings tends to increase during inflationary times - but rate of inflation tends to outpace interest rates
Inflation worries people about drop in standard of living, retirement