1 / 17

2.4A Inflation: What it is and Why low inflation is an important macro goal

B & D pages 221- 224 . 2.4A Inflation: What it is and Why low inflation is an important macro goal. Distinguish between inflation, disinflation and deflation.

elana
Download Presentation

2.4A Inflation: What it is and Why low inflation is an important macro goal

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. B & D pages 221- 224 2.4A Inflation: What it is and Why low inflation is an important macro goal

  2. Distinguish between inflation, disinflation and deflation. Discuss the possible consequences of a high inflation rate, including greater uncertainty, redistributive effects, less saving, and the damage to export competitiveness. Discuss the possible consequences of deflation, including high levels of cyclical unemployment and bankruptcies. Learning Objectives

  3. Inflation isNotjust a price rise of one particular good or service! It is expected that individual prices may rise or fall as supply or demand changes. But when most prices are going up, then there’s a problem in the whole economy.

  4. …a rise in the general price level of goods and services – usually measured by the Consumer Price Index. …measured as the rate of increase in the price level (% increase) over the previous year. Also note these adjectives to define types of inflation: • …“steady” if prices rise at same rate each year (e.g. 3% each year) • …“accelerating” if the rate is rising each year (e.g. 3%, 7%, 12%) • …"hyper" if already very high or skyrocketing (e.g. 80% each year) • … “disinflation” if the rate is decreasing each year (e.g. 3%, 2%, 1%) • Deflation is… price levels that actually decrease! Inflation is defined as…

  5. Complete the table: Price inflation for some banana republic

  6. Inflation often comes during periods of economic “boom” (i.e. sustained growth). But even if national income is rising, the rising price levels with “deflate” the value of money (recall GDP deflator). Hence inflation erodes “purchasing power” of money. • i.e. same money buys less goods and services. • Worse is when some people’s incomes don’t keep pace with inflation rates. It may be that real wages actually decrease. (recall: nominal wage – inflation = real wage) Especially hard hit are: • Those on fixed incomes (pension, welfare) • Those whose jobs aren’t in much demand Effects upon Households:

  7. Inflationary “expectations” creates the incentive to spend more and save less. (Why?) Those who put their savings into assets such as houses, stocks, etc. will increase income – often more than the inflation rate. Who’s incomes will likely increase more than others? High or low wage earners? 1+2+3= greater inequality of income distribution. Major issue: inequity increases

  8. An example: • Suppose you borrowed $1,000 for one year. • If you’re charged 15%interest , but during the year inflation was 10%... • really you’re only paying 5% interest The effect upon Interest Rates: • The nominal rate is the interest rate that a bank pays/charges. • The real interest rate is the nominal interest rate that is corrected for inflation. • Nominal interest rate – Inflation rate = Real interest rate Thus how will rising inflation affect consumption and investment?

  9. Nominal interest rate Inflation how would you graph the real interest rate? Interest Rates (percent per year) 15 10 5 0 -5 1998 1965 1970 1975 1980 1985 1990 1995

  10. A typical Progressive tax system • The first 30 000 – 20% • Then up to 60 000 – 33% • And beyond 60 000 – 40% Thus when wages - trying to keep pace with prices – increase, putting a taxpayer deeper into a high tax brackets – more tax is paid! Also For Households:“Fiscal creep” means more taxes paid

  11. Input costs (e.g. wages, raw materials) rise, thus decreasing AS • AD decreases due to higher priced exports • “Price uncertainty” makes business difficult: • The price mechanism isn’t clear: does higher prices imply more, less, or the same quantity demanded? • Increased time spent on accounting and planning becomes costly • “imported inflation” occurs when imported input costs rise due to inflation in another country Inflation Effect upon Firms: higher costs and failing price mechanism

  12. The effect of exchange rates: Why is there an inverse relationship here?

  13. Investment is encouraged through borrowing because: equity (total assets) increase in value, allowing firms to take on greater debt The principal decreases in real value – since its nominal value stays the same On the other hand, investment is discouraged because: Profits are more uncertain Profits can’t compete well with buying non-productive assets that are guaranteed to rise at the inflation rate For Investment: The good & Bad news

  14. Overall, low inflation is seen as extremely important for long-run growth

  15. Associated with negative growth as per ADAS model (see 2.2) Associated with high levels of cyclical unemployment and bankruptcies (see 2.4) Question: In an economy the interest rate falls from 9% to 7% and at the same time the rate of inflation falls from 8% to 5%. Explain why borrowers might in fact not be better off. Consequences of Deflation

More Related