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A Low and Stable Rate of Inflation

A Low and Stable Rate of Inflation

Daniel Broadley

on 5 April 2017

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Transcript of A Low and Stable Rate of Inflation

Consequences of inflation
A Low & Stable Rate of Inflation
Distinguish between inflation, disinflation and deflation.

Explain that inflation and deflation are typically measured by calculating a consumer price index (CPI), which measures the change in prices of a basket of goods and services consumed by the average household.

Explain that different income earners may experience a different rate of inflation when their pattern of consumption is not accurately reflected by the CPI.

Explain that inflation figures may not accurately reflect changes in consumption patterns and the quality of the products purchased.

Explain that economists measure a core/underlying rate of inflation to eliminate the effect of sudden swings in the prices of food and oil, for example.

Explain that a producer price index measuring changes in the prices of factors of production may be useful in predicting future inflation.
How do measure inflation?
Why an average of price for inflation? Why not just GUESS the ration of inflation!!
Why would prices rise?
Possible relationships between unemployment & inflation - HL
Phillips Curve
Previous Exam Questions - Delegate & distribute
Past Paper Questions


a) Explain why a country may wish to reduce its rate of inflation. [10 marks]

b) Evaluate the likely impact on the economy of relying on higher interest rates to reduce the rate of inflation. [15 marks]

M10/HP2 TZ2

Explain how inflation can be measured and explain three problems associated with the measurement of inflation. [10 marks]


a) Describe the main causes of inflation. [10 marks]

b) “If inflation is a major problem faced by governments it must follow that the opposite, deflation, is desirable.” To what extent do you agree with this statement? [15 marks]

What is the best way to bring inflation under control? Why?

Is inflation the most important macroeconomic objective?

What is the relationship between inflation and the rest of the economy e.g. unemployment, the current account and exchange rates, etc?

If the absoulte control of inflation is pursued how will other macroeconomic objectives be affected?

What’s the bigger evil, inflation or deflation? Why?
Match the ’costs’ with these pictures!
Costs of Inflation
Loss of Purchasing Power
Effects on Savings
Effects on Interest Rates
Effects on International Competitiveness
Labour unrest
Read the article from Brazil..
Costs of Inflation
”Deflation is a persistent fall in the average level of prices in the economy”
Improvements in the aggregate supply in the economy

Increased productivity

Shift in AS to the right – lower average price levels

More supply could mean more employment for growing industries
Good Deflation
Demand sided!

Fall in Aggregate demand – lower average price levels

Output then decreases

Unemployment rises

Bad Deflation
Costs of Deflation
Unemployment – Low AD – low purchase of durable goods – less employment

Investment – Less profit / or losses =low confidence &/or layoffs

Costs to debtors – A loan today will make debts more expensive as prices fall!
Costs of Deflation
Increasing aggregate demand
in the economy
Approaching full employment Fig 18.2
Increases in AD pull-up prices
Increases in the costs of
production domestically Note: Short-run AS fig 18.3
What is Inflation!
What is Deflation?
Inflation in a beast of it’s own! It creeps up on non-suspecting country’s
Fig 18.5
Demand-Pull + Cost Push
The meaning of inflation, disinflation and deflation
Consequences of deflation
Types and causes of inflation
Possible relationships between unemployment and inflation
Construct a weighted price index, using a set of data provided.
Calculate the inflation rate from a set of data.
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.
Explain, using a diagram, that demand-pull inflation is caused by changes in the determinants of AD, resulting in an increase in AD.

Explain, using a diagram, that cost-push inflation is caused by an increase in the costs of factors of production, resulting in a decrease in SRAS.

Evaluate government policies to deal with the different types of inflation.
Discuss, using a short-run Phillips curve diagram, the view that there is a possible trade-off between the unemployment rate and the inflation rate in the short run.

Explain, using a diagram, that the short-run Phillips curve may shift outwards, resulting in stagflation (caused by a decrease in SRAS due to factors including supply shocks).

Discuss, using a diagram, the view that there is a long-run Phillips curve that is vertical at the natural rate of unemployment and therefore there is no trade-off between the unemployment rate and the inflation rate in the long run.

Explain that the natural rate of unemployment is the rate of unemployment that exists when the economy is producing at the full employment level of output.
For Fun!! How much did Grandma really spend!!
Inflation is the
in the
AVERAGE price level
in the economy, usually calculated using the consumer price index
How do we measure prices in Sweden (here in Örebro?)
Think! Which 3 x price categories are the most influential for YOU compared to The King of Sweden? (p 226 also)
The Consumer Price Index (CPI) is a basket of goods measuring the average price level changes (mostly increases) in an economy.
What does this tell you about inflation rate collection and measurement?
Some BIG questions
So how does inflation happen? What causes it?
You tell me!!
Who / what influences prices?
Demand - Pull Inflation
Cost-push Inflation
Both types together?!
Excess Money Growth
increased consumer confidence or even more exports leading to more demand chasing limited goods & services
A shift to the right from AD1 to AD2 leads to a rise in the Real Ouput (Y1-Y2) and a rise in Average Price Level (P1-P2), thus
A shift of the SRAS1 to the left to SRAS2 leads to a fall in real output (y1-y2) and rise in average price level (p1-p2), thus
While many factors of production are domestically supplied, much inflation can be brought into a country through the import of goods & services. This is called
import-push inflation.
A fall in demand for a currency can also cause import-push inflation.
Do Student Workpoint 18.5
How could we use Fiscal & Monetary Policies to reduce this type of inflation?
Pro's & Con's? Winners? Losers? short / long term effects? What's your decision?
Do you care as much as they do?
(iii) Inflationary Spiral!!
(ii)higher wages – more money? More AD
(i) higher prices – higher costs of prodn – higher prices – higher wages – higher costs of prodn
How could we use Fiscal & Monetary Policies to reduce this type of inflation?
Pro's & Con's? Winners? Losers? short / long term effects? What's your decision?
Based on money supply of neo-classical macro economics
Fig 18.6
In the
businesses and consumers realise that this is not the case and the only lasting effect is inflation.
Businesses in the
mistake increased demand as a growing economy and can increase production to meet this demand.
How could we use Fiscal & Monetary Policies to reduce this type of inflation?
Pro's & Con's? Winners? Losers? short / long term effects? What's your decision?
In contrast,
is defined as a period where inflation rate is still positive
but declining.
represents the opposite of inflation, which means an increase in the overall
price level of goods and services over a certain period.
What they think in Sweden
How do calculate inflation? HL
There are many different areas of prices that we look at to measure inflation
Look at the table of non-weighted goods bought for two years.

We look at Year 1 in comparison to Year 2 and see the percentage increase (inflation).

That being Inflation rate = Year 2 - Year 1 / Year 1 x 100


Inflation Rate = Index for (X + 1) - Index X

Index for X x 100
Have a go yourself on page 238 -
Student Workpoint 18.9.
SHOW your working in detail as this is important to avoid mistakes and gain marks in the final exams!
Weighted price based inflation rates are better! (remember the exercise we did about the King's spending habits?!) See page 237!
weighted price
index is a basket of goods that are allocated a percentage or part of the inflation rate differently to account for their importance in our daily spending habits
Phillips Curve - Long Run
It was seen (and happily used by governments) to claim that there was a
between the two. That being you couldn't have both!

Governments thought that the cost of a low rate of Unemployment was a higher Rate of Inflation!

This led to strengthen the idea of AD management by keynesian economists.
fig 18.8 (at least in the short-run)
The Phillips curve suggests that there is an
inverse relationship
between the rate of change in money wages (not adjust) and the rate of unemployment.

Generally, the lower the unemployment rate, the higher the wage rate growth as an expanding economy competes for workers & vice verse

This idea was developed further to show the
inverse relationship
between the
Inflation rate and Unemployment Rate.
Monetarist economists (new-classicals)
after the 1970's gained for evidence for their claim that both a high rate of unemployment and a high rate of inflation are possible at the same time.

This was see in a
'supply shock
' of the rise of the price of oil in the 1970's.

See fig 18.10 on p 239.
Monetarists are a group of economists so named because of their preoccupation with money and its effects. The most famous Monetarist is Milton Friedman who developed much of the Monetarist theory we learn.

Monetarism is very closely allied with the classical school of thought. It is essentially an extension of classical theory which was developed in the 1960s and 1970s to try to explain a new economic phenomenon - stagflation.
When the labour market is at equilibrium and full-employment in the economy, the natural rate of unemploment is seen. The only was to reduce this is then through
supply sided policies
in the economy.
The idea being (new-classical Monetarist) is that we cannot change the LRPC with AD RATHER AS. This Natural Rate of Unemployment needs to be reduced through other means.
Group A
Group B
Group C
Group D
Group E
Group G
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