Inflation

1. Inflation

2. What is inflation? Causes of inflation Impacts of inflation Measuring inflation How to get rid of inflation. Or not?

3. What is inflation? • Inflation is a (rate of) general increase in prices and fall in the purchasing value of money. • Inflation is defined as a sustained increase in the general level of prices for goods and services in a county, and is measured as an annual percentage change. • To put it simply, inflation is the long term rise in the prices of goods and services caused by the devaluation of currency.  • Inflation is an increase in the money supply.

4. Decrease of purchasing power of money     =

5. What is inflation? Causes of inflation Impacts of inflation Measuring inflation How to get rid of inflation. Or not?

6. The Money Supply • Inflation is primarily caused by an increase in the money supply that outpaces economic growth. • Ever since industrialized nations moved away from the gold standard during the past century, the value of money is determined by the amount of currency that is in circulation and the public’s perception of the value of that money. When the Federal Reserve decides to put more money into circulation at a rate higher than the economy’s growth rate, the value of money can fall because of the changing public perception of the value of the underlying currency. As a result, this devaluation will force prices to rise due to the fact that each unit of currency is now worth less.

7. The Money Supply • One way of looking at the money supply effect on inflation is the same way collectors value items. The rarer a specific item is, the more valuable it must be. The same logic works for currency; the less currency there is in the money supply, the more valuable that currency will be. When a government decides to print new currency, they essentially water down the value of the money already in circulation. • A more macroeconomic way of looking at the negative effects of an increased money supply is that there will be more dollars chasing the same amount of goods in an economy, which will inevitably lead to increased demand and therefore higher prices.

8. The National Debt • As a country’s debt increases, the government has two options: they can either raise taxes or print more money to pay off the debt. • A rise in taxes will cause businesses to react by raising their prices to offset the increased corporate tax rate. Alternatively, should the government choose the latter option, printing more money will lead directly to an increase in the money supply, which will in turn lead to the devaluation of the currency and increased prices.

9. Demand-Pull Effect • The demand-pull effect states that as wages increase within an economic system (often the case in a growing economy with low unemployment), people will have more money to spend on consumer goods. This increase in liquidity and demand for consumer goods results in an increase in demand for products. As a result of the increased demand, companies will raise prices to the level the consumer will bear in order to balance supply and demand. • This happens not only when wages increase, but anytime people decide to spend much more money than before

10. Cost-Push Effect • Another factor in driving up prices of consumer goods and services is explained by an economic theory known as the cost-push effect. Essentially, this theory states that when companies are faced with increased input costs like raw goods and materials or wages, they will preserve their profitability by passing this increased cost of production onto the consumer in the form of higher prices. • A simple example would be an increase in milk prices, which would undoubtedly drive up the price of a cappuccino at your local Starbucks since each cup of coffee is now more expensive for Starbucks to make.

11. Exchange Rates • Inflation can be made worse by our increasing exposure to foreign marketplaces. • When the exchange rate suffers such that the U.S. currency has become less valuable relative to foreign currency, this makes foreign commodities and goods more expensive to American consumers while simultaneously making U.S. goods, services, and exports cheaper to consumers overseas. • This can stimulate the sales and profitability of American corporations by competitiveness in overseas markets. But it also makes imported goods, more expensive to consumers in the United States.

12. Also… • Inflation can be imported – due to higher prices of foreign goods and services (or raw materials), e.g. oil

13. What is inflation? Causes of inflation Impacts of inflation Measuring inflation How to get rid of inflation. Or not?

14. Costs of Inflation • Inflation affects different people in different ways, with some benefiting from its effects at the expense of some who lose out. It also depends on whether changes to the rate of inflation are anticipated or unanticipated. If the inflation rate corresponds to what the majority of people are expecting (anticipated inflation), then we can compensate and the impact isn't necessarily as severe. For example, banks can vary their interest rates and workers can negotiate contracts that include automatic wage hikes as prices go up.

15. Costs of Inflation Here is a brief account of the typical winners and losers from inflation: • Creditors (lenders) lose and debtors (borrowers) gain under inflation. • Inflation hurts savers since a dollar saved will be worth less in the future(unless the money is saved in an account that pays an interest rate at or above the rate of inflation). • Workers with fixed salaries or contracts that do not adjust with inflation will be hurt as the buying power of their incomes stay the same relative to rising prices.

16. Costs of Inflation • Similarly, people living off a fixed-income, such as those below the poverty line, retirees or annuitants, see a decline in their purchasing power and, consequently, their standard of living. • Landlords benefit, if they have a fixed mortgage (or no mortgage) as they are able to raise the rent more each year. • Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run.

17. Costs of Inflation • The entire economy must absorb repricing costs (menu costs) as price lists, labels, menus and more have to be updated. • If the domestic inflation rate is greater than that of other countries, domestic products become less competitive.

18. https://www.youtube.com/watch?v=Q_C3whhH2gc

19. What is inflation? Causes of inflation Impacts of inflation Measuring inflation How to get rid of inflation. Or not?

20. There are several variations on the theme of inflation. • Deflation is when the general level of prices are falling. It is the opposite effect of inflation. Deflation tends to occur more rarely and for shorter periods of time than inflation. Deflation occurs typically during times of recession or economic crisis and can lead to deep economic crises including depression. The reason for this is the so-calleddeflationary spiral: when prices are going down, why would you spend your money today, when each dollar will be more valuable tomorrow?

21. There are several variations on the theme of inflation. • Disinflation is a condition where inflation is still positive, but the rate of inflation is decreasing – for example from +3% to +2%. • Hyperinflation is unusually rapid inflation, typically more than 50% in a single month. This inflation can lead to the breakdown of a nation's monetary system or even its economy. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month! Hyperinflations have also famously occurred in Zimbabwe, Hungary and Argentina

22. Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year.  • Consumer Price Index (CPI) - A measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser.

23. CPI • The Consumer Price Index (CPI) uses a "basket of goods" approach that aims to compare a consistent base of products from year to year, focusing on products that are bought and used by consumers on a daily basis. The price of your milk, eggs, toothpaste and a hair cut are all captured in the CPI.

24. How it works • The CPI measures the retail price changes of about 80,000 goods and services (in U.S.) purchased by consumers, called a market basket. The market basket covers over 180 categories falling into eight major groupings: • Food and beverage,Housing, Apparel, Transportation, Medical care, Recreation, Education and communication, Other • The market basket is updated every few years to remove goods and services that might have become obsolete or irrelevant. • Percentage changes in CPI measures inflation.

25. https://www.youtube.com/watch?v=0jJKjgE3qfE • Quantitative equation: • https://www.youtube.com/watch?v=q59tZKP0HME&index=46&list=PL-uRhZ_p-BM52EbMG1NR1ZfG9tEvcxE4u

26. What is inflation? Causes of inflation Impacts of inflation Measuring inflation How to get rid of inflation. Or not?

27. The Good Aspects of Inflation • Another way of looking at small amounts of inflation is that it encourages consumption. For example, if you wanted to buy a specific item, and knew that the price of it would rise by 2-3% in a year, you would be encouraged to buy it now. Thus, inflation can encourage consumption which can in turn further stimulate the economy and create more jobs. • However, as some inflation may be good on macroeconomic level, on microeconomic level it might be quite bad for someone (individuals my not like higher prices)

28. The Good Aspects of Inflation • In a fact that is surprising to most people, economists generally argue that some inflation is a good thing. A healthy rate of inflation is considered to be approximately 2-3% per year. The goal is for inflation (which is measured by the Consumer Price Index, or CPI) to outpace the growth of the underlying economy (measured by Gross Domestic Product, or GDP) by a small amount per year. • A healthy rate of inflation is considered a positive because it results in increasing wages and corporate profitability and keeps capital flowing in a presumably growing economy..

29. One popular method of controlling inflation is through contractionary monetary policy. The goal of a contractionary policy is to reduce the money supply within an economy by decreasing bond prices and increasing interest rates. • This helps reduce spending because when there is less money to go around, those who have money want to keep it and save it, instead of spending it. It also means less available credit, which also reduces spending. Reducing spending is important during inflation because it helps halt economic growth and, in turn, the rate of inflation.

30. Inflation is generally controlled by the Central Bank and/or the government. The main policy tools to control inflation include: • Monetary policy – Setting interest rates. Higher interest rates reduce demand, leading to lower economic growth and lower inflation • Control of money supply – Monetarists argue there is a close link between the money supply and inflation, therefore controlling money supply can control inflation. • Supply side policies – policies to increase competitiveness and efficiency of the economy, putting downward pressure on long-term costs.

31. The main policy tools to control inflation also include: • Fiscal policy – a higher rate of income tax could reduce spending and inflationary pressures. • Wage controls. Trying to control wages could, in theory, help to reduce inflationary pressures.

32. Thank you for attention!