Inflation

General terms

DEFLATION = opposite to inflation, occurs when the general level of prices is falling

DISINFLATION = describe the process of reducing a nation’s rate of inflation

STAGFLATION = high inflation in periods of high unemployment

REVALFLATION = impact of inflation, where the result is an inner valorisation of exchange rate

Rate of inflation

1

1

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levelprice

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PRICE INDEXES

• Consumer price index (CPI) - each item is assigned a fixed weight proportional to its relative importance in consumer expenditure budget

• Producer price index (PPI) - measures the level of prices at the wholesale or producer stage

• GDP deflator – the ratio of nominal GDP to real GDP can be interpreted as a comprehensive price index

10000

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10001

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Numerical Example

Calculate the consumer price index and the rate of inflation for 2006.

Base year (2000)

Weigh (%) Price

2006

Weigh(%) Price

Food 20 100 20 102

Shelter 50 100 50 106

Medical care

30 100 30 110

Categories of Inflation according to its pace/rate:

MODERATE INFLATION – occurs when prices are rising slowly (we might classify this as single-digit annual inflation rates 0-10 % per year)

GALLOPING INFLATION - occurs when prices start rising at double-or-triple digit rates (20, 100 % a year)

HYPERINFLATION – the extraordinary price increase (at annual rate of 100 % or more prevailing in a nation for at least one year)

Inflation according to:

a) its impact on individual commodity:

Balanced – leaves relative prices unchanged all prices are rising at the same percentage point each year it doesn’t cause a change in consumption structure

Unbalanced – some prices are increasing faster than the general price level there can be seen an expressive impact on the demand and consumption structure

b) predictability

Anticipated Unanticipated

Inertial inflation = tends to stay at its prior rate until shocked by economic events.

IMPACT OF INFLATION „cost of inflation“

1) Redistribution of income and wealth

2) Social impacts

3) Impact on balance of economy

SUMMARY OF IMPACTS

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

generally, the economic impact of an unanticipated moderate inflation is mainly on the distribution of income and wealth, and less on the efficiency of the system

the mildest impact will be found when inflation is at a low rate – small, anticipated and balanced

major social and economic impacts arise for galloping inflation or hyperinflation

Causes of Inflations

1.DEMAND-PULL INFLATION

- the essence of demand-pull inflation is too much spending beating against a limited supply

2. COST-PUSH INFLATION

- first appeared during the 1930’s and the 1940’s

- inflation caused by continual decrease in aggregate supply

THE PHILLIPS CURVE

the Phillips curve depicts the relationship between unemployment and inflation, both in percent

SHORT-RUN PHILLIPS CURVE a nation could buy a lower level of

unemployment if it were willing to pay the price of a higher rate of inflation

The shifting Phillips curve

„Boom cycle“

Period 1: unemployment is at the natural rate; no demand or supply surprises; economy is on the lower short-run Phillips curve

Period 2: rapid increase in output during an economic expansion (f. e. as a result of expansion policy) lowers the unemployment rate wages and prices begin to accelerate the economy moves up and to the left along the short run PC

Period 3: Firms and workers begin to expect higher inflation higher expected rate of inflation gets incorporated into wage and price decisionsthe short-run PC shifts upward

Period 4: unemployment rate returns to the natural rate; contraction in economic activity brings output back to its potential.

The vertical Long-Run Phillips curve

When the unemployment rate diverges from the NRU the inflation tends to change

According to the natural rate theory, the only level of unemployment consistent with a stable inflation rate is the natural rate of unemployment the long-run PC is a vertical line rising straight up at the NRU

Two important implications for economic policy: 1) there is a minimum

level of unemployment that an economy can sustain in the long run;

2) the nation can temporarily enjoy low rate of unemployment, but at the expense of rising inflation

WAYS (COSTS) OF DISINFLATION: Temporary increase in

unemployment above the NRU Income policies (wage- price

control or voluntary guidelines)

1. Calculate the CPI and IPD, if following amount of products was consumed in economy:

Product 1.Year 2. Year

Price Quantity Price Quantity

A 16 120 000 21 142 000

B 820 31 000 815 33 100

C 3 600 290 4 050 270