INFLATION. Measures Types Causes Effects

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1 INFLATION Measures Types Causes Effects

2 What is inflation? Inflation measures how much more expensive a set of goods and services has become over a certain period, usually a year Prices of goods and services consumed by consumers and the share of each good or service in the household budget affects consumers cost of living Ceyda Öner, IMF Conducting household surveys Tracking cost of purchasing this basket over time Identification of a basket of commonly purchased items CPI

3 Consumer price index (CPI) CPI = cost of basket at a given time expressed relative to a base year is the Consumer price inflation = percentage change in the CPI over a certain period is, = the most widely used measure of inflation Example: base year, CPI is 100, current CPI is 110 -> inflation is 10 percent over the period Other indexes: (producer PI, commodity PI, ) CPI t CPI t 1 Rate of inflation: r *100% CPI t 1

4 Types of Inflation Open inflation if economic imbalance is accompanied with rising price level. Suppressed inflation if state authorities damp or even stop the rise of price level by administrative means. But, by this way causes of inflation cannot be removed. Such situation is followed by existence of scarce commodities, shadow economy etc. Hidden inflation if official price indexes do not reflect the price of goods and services produced by shadow economy.

5 Types of inflation (quantitative perspective) Type R [%] Creeping < 10 beneficial to economic growth Galloping economy becomes unstable sets expectations that prices will continue to rise -> increased demand and drives economic expansion Money loses value quickly, foreign investors avoid country Hyperinflation > 100 out of control prices increase rapidly as a currency loses its value, barter Deflation < 0 bad for economy why would you spend your crown today when the expectation is that it could buy effectively more stuff tomorrow? -> decreases demand

6 Nationalization of farms and companies Experienced managers replaced by loyal politicians Extensive decrease of productivity No foreign investments, lack of food Increase of black market, high unemployment Fall of zimb. dollar (2009), people allowed to use (US dollar was preferred)

7 Causes of Inflation Demand-pull inflation Arises when aggregate demand in an economy outpaces aggregate supply It involves inflation rising as real gross domestic product rises and unemployment falls. This is commonly described as "too much money chasing too few goods". Possible causes of demand-pull inflation: Excessive investment expenditures Excessive growth of consumption expenditures Low-cost loans Tax cutting Augmentation of government expenditures

8 Causes of Inflation Cost-push inflation (or supply-shock inflation) is a type of inflation caused by large increases in the cost of important goods or services where no suitable alternative is available. A situation that has been often cited of this was the oil crisis of the 1970s, which some economists see as a major cause of the inflation experienced in the Western world in that decade. Possible causes of cost-push inflation: Imperfect competition Rising wages Political incidents (like oil crises)

9 Causes of Inflation Built-in inflation (or Anticipated inflation) induced by adaptive expectations, often linked to the "price/wage spiral it involves workers trying to keep their wages up with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

10 Effects of Inflation Redistribution effect of inflation Inflation affects recipients of fixed income firstly (nominal incomes remain same but the real value of income drop) Inflation affects the purchasing power of wages that don t follow the rise of prices Inflation causes diminishing value of loans and savings Social impact of inflation Socially poor persons suffer from inflation more then rich

11 Effects of Inflation Impact on economy balance Fall of real product bellow potential product Changes in the structure of consumption (consumers are buying cheaper goods) In case of fixed currency exchange rate higher exports are incited Inflation deforms prices Inflation causes higher costs and makes economy less efficient Creeping and anticipated inflation has positive effect on economy and stimulates economic growth High inflation and not anticipated inflation signalize serious problems in economy.

12 Stopping the inflation There are a number of methods which have been suggested to stop inflation. Managing the wages and prices determined by state income policy (authority can set wages ceiling) Stimulating market competition e.g. antimonopoly regulations Fiscal and monetary policy e.g. central banks can affect inflation to a significant extent through setting interest rates Switch to a stable currency

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