Economics 12 Inflation & Unemployment Ms. Park

Next Presenters Amy

Review What’s the difference between CPI and GDP deflator? What do you use when you want to calculate Real income? Real GDP?

Inflation Effects Inflation redistributes purchasing power among different groups in ways that can be both economically harmful and unjust; purchasing power keeps pace with inflation for some individuals, but not for others.

Q&A: What are: Full indexation Partial indexation Fixed incomes Full indexation: nominal income rises at the inflation rate Partial indexation: nominal income rises at less than the inflation rate Fixed incomes: nominal income stays constant

Inflation Effect Cont. Household incomes: Inflation means not only increasing prices but expanding nominal incomes as well. The effect on households’ purchasing power depends on which is greater- inflation or the increase in nominal income. Loosing purchasing power, maintaining purchasing power, gaining purchasing power.

Borrowing & Lending Inflation can also redistribute purchasing power between borrowers and lenders actual inflation > anticipated inflation  Borrowers win actual inflation < anticipated inflation  Lenders win actual inflation = anticipated inflation  No one affected

Nominal vs. Real interest rate Nominal interest rate: the interest rate expressed in money terms Real interest rate: nominal interest rate – inflation rate Inflation premium: % built into a nominal interest rate to anticipate the rate of inflation for the loan period *Inflation premium = anticipated inflation Desired real interest rate = Nominal interest rate - inflation premium

Example The nominal interest rate is 8%, the inflation premium on loans is 3%, and actual rate of inflation 5%. What is the real interest rate? Find the difference between this rate and the desired real interest rate and explain how any difference affects borrowers and lenders.