Inflation Chapter 7

Inflation Widespread, persistent price increases Widespread, persistent price increases Low inflation is a basic macroeconomic goal Low inflation is a basic macroeconomic goal Price level: prices of goods and services in the aggregate Price level: prices of goods and services in the aggregate

Inflation Inflation rate Inflation rate The annual percentage increase in the price level The annual percentage increase in the price level 3% or less – most Americans are satisfied 3% or less – most Americans are satisfied Deflation Deflation Inflation rate is negative Inflation rate is negative

Harm from Inflation Inflation hurts Inflation hurts Fixed income Older generation Creditors Inflation helps Inflation helps Younger Debtors

Life Cycle Theory Young are debtors so pay back with cheaper dollars Young are debtors so pay back with cheaper dollars Old are creditors and save with smaller dollars Old are creditors and save with smaller dollars

Inflation Anticipated inflation Anticipated inflation Expected by the public Expected by the public Protect themselves Protect themselves Unanticipated inflation Unanticipated inflation Unexpected by the public Unexpected by the public Harmful Harmful An increase in inflation that cause the inflation rate to be higher than expected provides borrowers with a windfall An increase in inflation that cause the inflation rate to be higher than expected provides borrowers with a windfall

Indexing to Offset Indexing Indexing Automatically adjusting the terms of an agreement for inflation Automatically adjusting the terms of an agreement for inflation COLA – clauses in labor agreement are a form of wage indexing COLA – clauses in labor agreement are a form of wage indexing Interest rate Interest rate The price of borrowed money; expressed as a percentage The price of borrowed money; expressed as a percentage Index to inflation Index to inflation

Measuring Inflation Consumer Price Index (CPI) Consumer Price Index (CPI) Measures prices of a market basket of purchases made by consumers living in urban areas Measures prices of a market basket of purchases made by consumers living in urban areas Collection of goods and services used in the calculation of the CPI Collection of goods and services used in the calculation of the CPI Producer Price Index (PPI) Producer Price Index (PPI) Measures wholesale prices, which are prices paid by firms