Economics I Inflation and Anti-inflationary Policy (2h)

Inflation and Anti-inflationary Policy The aim of this lecture is to analyze inflation as one of the basic macroeconomic instability. Inflation is a macroeconomic phenomenon that attracts a lot of attention and affects all of us, because it devaluates our money. Equally disturbing, as we shall see, is deflation. The lecture will deal with ways of measuring inflation, inflation forms, discuss the effects of inflation on the economy and takes into account the possibilities of the state how to alleviate the increase of inflation rate. An essential part of the anti- inflation policy of the Czech National Bank can be present in the form of inflation targeting.

Content introduction – defining the goals definitions and ways of measuring inflation the causes and forms of inflation the effects of inflation in the economy anti-inflationary macroeconomic policy conclusion – summary, homework

Definitions and ways of measuring inflation inflation = an increase in the general price level over time, reducing the purchasing power of money (vs. disinflation, deflation). The Czech Statistical Office definition: the inflation rate as an increase in the average annual consumer price index (CPI) is calculated as the percentage change in the average price level for the last 12-month average of the 12 previous months. – this inflation rate is useful when editing or assessment of average quantities, shall be taken into account when calculating real wages, retirement pensions, etc. 4

the price indexes are used to measure the price level - weighted average prices of selected goods and services, the CPI is the most widely used, it means Consumer Price Index (cost of living index) the development of consumer prices (cost of living) is measured on a sample of goods and services paid for by population price representatives are chosen products and services that contribute significantly to the expenditure of the population and cover the entire sphere of consumption 5 Measuring inflation

The calculation of the rate of inflation using the CPI: the proportion of the cost of a representative basket of consumer at time t cost of acquisition of the basket in the base period. CPI = Inflation rate (π): growth rate of the CPI : π = 6 Σ p t i. q 0 i Σ p 0 i. q 0 i i = goods or services. 100 [%] double pricing in the consumer basket CPI t – CPI t – 1 CPI t – [%] Inflation rate measurement – by the CPI

there are certain problems using the CPI (consumer basket setting, restricted amount of goods and services) Implicit Price Deflator (IPD) - the ratio of nominal and real GDP: IPD = accelerating the growth rate of the price level (P) = acceleration of inflation; slowdown in growth rate of the price level (P) = deceleration of inflation inflation expectations and inflation inertia, inflation spiral 7 nominal GDP real GDP. 100 [%]

The causes and forms of inflation causes of inflation: demand-side (AD growth, making full use of resources), on the supply side of the economy (SRAS decrease) the breakdown of inflation according to a quantitative perspective: – mild (creeping) – galloping – hyperinflation open (apparent) vs. blocked (repressed) inflation; hidden inflation even vs. uneven inflation expected vs. unexpected inflation inertial inflation, stagflation 8

9 Demand-pull inflation P Y (GDP r ) LRAS Y*Y* SRAS AD AD´ Y´ P1P1 P2P2 AD, the economy is closed to Y*, P inflationary gap

10 Cost-push inflation P Y (GDP r ) LRAS Y*Y* SRAS AD Y´ P1P1 P2P2 SRAS, P SRAS´ output gap

the redistribution of wealth in the economy, redistribution of income from creditors towards debtors redistribution between the government and the private sector depreciation of all fixed income, transfers, savings and interests the nominal interest rate increases, the Fisher Equation: i n = i r + π e problems in the progressive tax system: taxflation uncertainty in economic decision-making bodies, shortening their time horizons, decline in investment activity deformation in the allocation of inputs and outputs for unbalanced in inflation negative impact on the quality of price information additional costs (changes in the structure of assets, the cost of announcements of price increases) deformace při alokaci vstupů i ve výstupech při nevyrovnané inflaci 11 The effects of inflation in the economy

The AD regulation by the restrictive economic policy (aimed against demand-pull inflation) efforts to reduce inflationary expectations (conservative streams) income policy, price regulation inflation targeting in the Czech Republic since 1998 (approved in December 1997) 12 Anti-inflationary macroeconomic policy

Literature FRANK, R. H., BERNANKE, B. S. Principles of Macroeconomics. 3rd Edition. McGraw- Hill/Irwin: NY, ISBN p. MANKIW, G. N. Principles of Macroeconomics. 4 th ed. USA: Thomson South- Western, p. ISBN McCONNELL, C. R., BRUE, S. L. Economics: Principles, Problems, and Policies. 17th ed. NY: McGraw/Irwin. 716 p. ISBN SAMUELSON, P. A., NORDHAUS, W. D. Economics. 15th ed. McGraw-Hill, 1995.

Internet sources Czech National Bank. Inflation targeting. Available at www: Czech Statistical Office. Macroeconomic data (average annual rate of inflation). Available at www:

Homework Exercise “Inflation and Anti-inflationary Policy” Consumer basket consists of five properties: Swiss roll (good A), rabbit (good B), grassland (good C), pickled cabbage (good D) and Scottish whiskey (good E). Prices of goods in the base period: P A = 12 CZK, P B = 40 CZK, P C = 8 CZK, P D = 15 P E = 200 CZK. Prices of goods in the current period: P A = 11 CZK, P B = 35 CZK, P C = 9 CZK, P D = 18 CZK and P E = 220 CZK. The amount of individual good (share in the consumer basket): Q A = 10, Q B = 5, Q C = 32; Q D = 6 and Q E = 4. Calculate the CPI index. Find the website of the Czech National Bank (CNB): read section about targeting inflation in the Czech Republic and make a brief comment. Are there any exceptions to the application of anti-inflation policy of the Czech National Bank? If there are, make some notes.