Inflation Economic Challenges

INFLATION Economic condition of Average Prices Rising Jeans $ Jeans$ GDP goes up => output remains the SAME (real GDP unchanged) –Real = adjusted for inflation Consumer Price Index (CPI) measures inflation –Goal is to have inflation below 2.0%

REAL INFLATION When Prices ↑ faster than Income ↑ (then consumers notice!) 2010 Inflation Overall +3.6% College + 8.0%

Why is inflation Bad? Difficult for Business to plan & price goods/services Difficult to fight once it begins to rise –Must significantly raise interest rates (tight monetary policy) Lowers your purchasing power Leads to lower GDP in the long run

Inflation robs YOU of Purchasing Power Purchasing Power = amount of goods & services money buys Inflation Calculator

Historical Inflation Germany: “hyperinflation” after World War I –Currency became worthless USA:Late 1970s Stagflation—inflation at +13% –Federal Funds rate rose to 15% to fight inflation in the 1980’s –Very rare combination of recession & inflation USA: low inflation since 1985 [ %] –Economists are generally not concerned about inflation in 2012 –Some economists fear the current “loose” monetary policy

2-Types of Inflation Demand-Pull Inflation: –Too many dollars chasing too few goods –printing too much money causes it… –Demand Side Inflation Cost-Push Inflation –Increase in cost of any factors of production –examples: price of oil, wages, steel, etc…. –Supply Side Inflation

Who is Helped by inflation? People in large amount of Debt –Large Mortgages, Car Loans, Student Loans If you owe 1 million dollars Inflation lets you pay your debt back in inflated dollars

Who is Hurt by Inflation? People on a fixed income, savers –Assuming you borrow with a fixed rate loan If you receive $1,000 a month (for life) Inflation lowers your purchasing power

Inflation Handout