Inflation Macroeconomics

Inflation… what is it?  An increase in the economy’s price level  The price level is the weighted average of prices  A decrease in money’s purchasing power

What causes inflation 2 immediate causes (what starts it) – Demand-pull – Cost-push Ultimate cause (what sustains it) – Too much money chasing too few goods This can lead to hyperinflation The wage-price spiral

How’s inflation measured Consumer Price Index (CPI) – Used to measure consumer inflation – Market basket approach – Quick, efficient – Ignores consumer substitution, quality changes GDP deflator – Measures entire economy’s inflation – Includes everything – Used to deflate nominal gdp

2 ways inflation is reported  CPI Headline inflation  Includes entire CPI market basket  CPI Core inflation  Excludes food and energy because they are volatile

Who does inflation effect?  Everybody  Who wins?  Those with large debt  Those who borrowed at low fixed interest rates  Those who make fixed payments  Who loses?  Those with large cash savings  Those who lent at low fixed interest rates  Those receiving fixed payments

Expectations  Expecting inflation causes inflation  Consumers demand more  Producers supply less  The role of the central bank  Control actual inflation by controlling expected inflation  The importance of credibility

Disinflation and Deflation Disinflation – Decrease in the inflation rate Going from 7% inflation to 2% inflation – Disinflation is good for the economy – Referred to as price stability Deflation – Negative inflation rate prices falling – Deflation is bad for the economy – Creates perverse incentive to delay spending on durable goods and capital investments