Economics Chapter on Inflation

Inflation

• Inflation is a sustained rise in the general price level over time, reducing the purchasing power of money.
• Deflation is the opposite, where the average price level falls, and there is a negative inflation rate.
• Disinflation is when the average price level is rising, but at a slower rate.

Distinction between Money Values and Real Data

• Nominal value is the money value of data.
• Real value is the data adjusted for inflation.
• Real GDP is the GDP adjusted for inflation, indicating the true economic growth.
• Nominal GDP is the GDP without inflation adjustment, potentially overstating growth.

Causes of Inflation

Demand-Pull Inflation

• Occurs when aggregate demand grows unsustainably, putting pressure on resources.
• Causes include:
  • Depreciation in exchange rates (imports more expensive, exports cheaper)
  • Fiscal stimulus (lower taxes, increased spending, increasing disposable income)
  • Lower interest rates (encouraging spending and borrowing)

Cost-Push Inflation

• Occurs when firms face rising costs.
• Causes include:
  • Increased raw material prices (e.g., oil)
  • Increased labor costs (e.g., wage increases)
  • Expectations of inflation (higher wages to compensate)
  • Indirect taxes (e.g., on fuel or cigarettes)
  • Monopolies exploiting market power

Growth of Money Supply

• Excessive increases can lead to hyperinflation—uncontrollable rapid inflation.
• Relevant in cases where money supply grows faster than real output.
• Quantitative easing (QE) is a tool used by central banks to stimulate the economy, increasing money supply and lowering interest rates.

Effects of Inflation

Consumers

• Low and fixed incomes are most affected by inflation due to its regressive nature.
• Cost of necessities (food, water) becomes a bigger issue.
• Inflation reduces the real value of debt (if loans are not adjusted)

Firms

• Low interest rates may encourage investment, however, higher interest rates are more likely during high inflation decreasing investment.
• Price competitiveness can decrease if inflation is higher than in competitor countries.
• Uncertainty about future costs can reduce investment.

Workers

• Real incomes fall with inflation, leading to lower disposable income.
• Increased costs for firms could lead to redundancies.

Government

• Government payments need adjustment to compensate for rising costs during inflation.