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Inflation: Is it really all bad?

Inflation: Is it really all bad?. Mrs. Jeane McNamara GVHS: SP 2002. What is Inflation?. Sustained increase in price level. Is inflation all bad?. Depends!--The key is that increases in real wages must be > increase in the price level. What is impacted by inflation?.

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Inflation: Is it really all bad?

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  1. Inflation: Is it really all bad? Mrs. Jeane McNamara GVHS: SP 2002

  2. What is Inflation? • Sustained increase in price level

  3. Is inflation all bad? • Depends!--The key is that increases in real wages must be > increase in the price level

  4. What is impacted by inflation? • Purchasing power: given a fixed sum of $, what goods/services will it buy? • Real wages: what is the purchasing power of your wages

  5. Does inflation erode wages? • DEPENDS! Remember, REAL wages must be > rate of inflation • COLA--”Cost of Living Adjustment”--If the COLA is tied to at or above inflation, the wage earner is ok

  6. Inflation does NOT... • SYSTEMATICALLY erode purchasing power (price changes could be tied to a specific sector of the economy) • DOES NOT lead to unfair prices • SHOULDN’T be blamed when the price of one good goes up relative to the price of another good

  7. Who is hurt by inflation? • Lenders at fixed rates (lower than the rate of inflation) • Savers at fixed rates (lower than the rate of inflation) • Borrowers at variable rates (adjustable rates are tied to inflationary indecies) • Income earners at fixed wages (e.g. contract/union workers)

  8. Who is hurt by inflation?(con’t) • Those individuals living on fixed incomes (NOTE: SS does allow for a COLA, but it isn’t always tied to the rate of inflation) • Consumers, unless wages keep pace

  9. Who is helped by inflation? • Borrowers at fixed rates (lower than the rate of inflation) • Lenders at adjustable rates

  10. Conclusions about inflation • Inflation tends to arbitrarily redistribute income

  11. Interest rates and inflation • The Real Rate of Interest = i-rate adjusted for inflation = TRUE borrowing power • The Nominal Rate of Interest = ‘expected’ interest rate + inflation = % i-rate borrower pays lender not adjusted for inflation

  12. Interest rates and taxes • Our tax system was designed for an inflation-free economy--taxes tax nominal interest rates • Conclusion: in periods of high inflation, taxes penalize interest income because our tax system doesn’t distinguish between real and nominal interest rates

  13. Interest rates and taxes (con’t) • THEREFORE: Savings and Investment are DISCOURAGED by our own tax system

  14. Types of Inflation • Creeping--Upward pressure on the price level at a steady pace • Bracket Creep--inflation pushing wage earners into higher tax brackets • Galloping--spikey increases (ex: post WWI Germany, Latin countries)

  15. Types of Inflation (con’t) • Dis-inflation: a sustained period of little or no inflation • Deflation: sustained decreases in the price level

  16. How is the inflation rate measured? • Representatives from the Commerce Department purchase the “market basket” of goods and services to come up with a “Consumer Price Index” (CPI) • Economists like the “core inflation” measure--the CPI with food and energy extracted

  17. Problems with the CPI • Often overstated as the market basket doesn’t change in step with consumer preference and/or regional demand

  18. What’s the difference between “cost-push” and “demand-pull” inflation? • Demand-pull inflation is driven by increased demand in the economy for goods and services • Cost-push inflation is driven by increased costs of production

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