Coach Guttmann Economics Inflation Coach Guttmann Economics

Inflation – Definition Inflation is an increase in the general level of prices It is measured by the Consumer Price Index (CPI) (CPI = current year prices/base year prices x 100) Deflation is a lowering of the prices level like when a financial “bubble” bursts

Types of Inflation Expected – the normal rate (1-2% a year) “Unanticipated” = higher than expected rate Creeping = 3% or less Galloping = 10 – 25% Hyperinflation = > 50% a month (@ 600% a year) Stagflation = rising unemployment and prices

How Inflation is graphed US Economy AS1 PL AS PL = Price Level Prices for whole US AS = Aggregate Supply Supply for whole US AD = Aggregate Demand Demand for whole US rGDP = Real GDP GDP adjusted for inflation P2 P1 AD rGDP GDP1

How Inflation is caused Cost - Push Demand - Pull AS1 PL AS PL AS P2 P2 P1 P1 AD1 AD AD rGDP rGDP GDP1 GDP1

How does Inflation effect you? Who gains? Who it hurts? Borrowers who pay back at a fixed rate Stock investors Commodity investors Lenders who get paid back at a fixed rate Savers Retirees on fixed income Bond investors

Adjustable Rates Rates that vary – depend on indexes that reflect price level changes C.O.L.A. (Cost of Living Adjustment) A.R.M. (Adjustable Rate Mortgage) Borrowers and Lenders may be effected differently because of lag time of rate changes

Practice – Hurt, Gain, or Uncertain? For each of the following scenarios, determine if the individual is helped or hurt by (unexpected) inflation. Explain each answer.

#1 – Hurt, Gain, or Uncertain? Jack retired five years ago and now lives on a fixed-income annuity and a small savings account that pays him 1% interest on the balance. The current inflation rate is 1.7%

#1 – Hurt, Gain, or Uncertain? Jack retired five years ago and now lived on a fixed-income annuity and a small savings account that pays him 1% interest on the balance. The current inflation rate is 1.7% Jack is HURT - His income is less than inflation

#2 – Hurt, Gain, or Uncertain? Jill has worked at her current position without a raise for 4 years. Because inflation has risen 5% over the course of the 4 years, she has struggled to pay day-to-day living expenses and her house payment. She asked her employer for a raise and he gave her a 6% raise because she is such a good worker.

#2 – Hurt, Gain, or Uncertain? Jill has worked at her current position without a raise for 4 years. Because inflation has risen 5% over the course of the 4 years, she has struggled to pay day-to-day living expenses and her house payment. She asked her employer for a raise and he gave her a 6% raise because she is such a good worker. Jill GAINS - Her raise is more than inflation