inflation and interest rates L10 M2 economics
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inflation and interest rates L10 M2 economics - Marcador
inflation and interest rates L10 M2 economics - Detalles
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| 🇬🇧 | 🇬🇧 |
| What is inflation | Rate at which prices for goods and services increase over time. |
| What is hyper inflation | Rapid increase in prices, result of printing excess money |
| Deflation | Sustained period when the general price level for goods and services is falling. the annual rate of inflation is negative |
| Whats disinflation | Fall in the rate of inflation but not sufficient enough to bring price deflation. consumer prices are rising but at a slower rate |
| Inflation expectations | – what ppl and businesses expect to happen to consumer prices in the future. |
| Wage price spiral | When ppl expect higher prices, this can then feed thru to higher wage claims and rising costs |
| Stagflation | Combo of stagnant (slow) economic growth, rising unemployment and high rising inflation |
| Consumer price index | Indicator for assessing inflation and cost of adjustment. Calculated the current prices of the items in the basket to the prices of the same items in a base year or period. Percentage change in this comparison reflects the inflation or deflation rate. |
| Limitation of CPI | 1. Not fully representative of all consumers 2. Error / inaccuracies in data 3. Many of services in digital economy don’t have a price such as google searches 4. Changing quality of goods and services 5. Time lags. |
| Challenges In measuring inflation | 1. Basket of goods and services 2. substitution bias 3. quality adjustments 4. geographic variation 5. subgroups and demographics |
| Main causes of inflation | 1. Money and credit boom 2. Higher wage costs 3. Increased energy bills 4. Falling exchange rate 5. Higher indirect taxes 6. Economic boom |
| Whats cost push inflation | When businesses respond to rising unit costs by increasing prices to protect their profit margins |
| Causes of cost push inflation | 1. Rising labour costs perhaps due to an increased minimum wage 2. Higher global prices for components and raw materials including imported energy 3. A depreciation in the external value of the exchange rate which then causes a rise in imported prices – many imported priced in us dollars 4. An increase in indirect taxes such as higher VAT or environmental taxes such as carbon tax |
| Demand pull inflation | Accelerating inflation which arises from rapid growth in ag demand. Occurs when economic growth is too fast. |
| Causes of demand pull inflation | 1. economy growing too fast 2. prices start to rise 3. low interest rates and increase in money 4. gov engages in fiscal stimulus, like cutting taxes or increasing spending 5. inflation |
| Monetarism | Amnt of moneys in an economy plays crucial role in determining the overall price level or inflation |
| Equation of exchange | MV = PQ M = money supply V = velocity of money P = price level Q = quantity of goods and services produced. |
| Quantity theory of money | Price level in an economy is directly related to the money supply |
| What happens when there's an increase in the supply of money | Decreases the marginal value of money. |
| Reasons for acceleration In inflation in the uk | 1. Rising cost of energy 2. Increasing cost of food 3. Profit push inflation from suppliers |
| Greedflation | Charging excessive prices for goods or services in response to a situation of increased demand or limited supply. |
| Shrinkflation | – the practice of companies reducing the size or quantity of a product, while keeping the price the same or even raising it. |
| What does the central bank do to curb inflation | Raise interest rates |
| What happens when there's bonds | When a gov issues new bonds, it has to offer a certain interest rate, known as the yield, to attract investors. Inflation more, yields higher. |
| Whats inequality | Inflation has a regressive effect on lower income families in developed and developing countries – most of their wealth is held in cash |
| Falling real incomes | – if wage rises lag prices increases each year |
| Negative real interest rates | – if the interest rate on savings is lower than inflation |
| Cost of borrowing | – high inflation may also lead to higher interest rates for businesses and consumers with debts |
| International competitiveness | High relative inflation can reduce competitiveness which will lower demand for the country’s exports |
| International competitiveness | – high relative inflation can reduce competitiveness which will lower demand for the country’s exports |
| Business uncertainty | – high and volatile inflation isn’t good for confidence by businesses are not sure what costs will be – may hold back investment. |
| Gainers from high inflation | Workers with strong wage bargaining power, debtors and producers |
| Losers from high inflation | Retired ppl, lenders, savers and workers in low paid jobs. |
| Costs of high inflation or gov | 1. Pressure on gov 2. Real GDP growth will slowdown 3. Increase market interest 4. Worsen international competitiveness |
| Benefits of high inflation for gov | 1. Leads to fiscal drag (a phenomenon when people who get pay rises are dragged into paying a higher rate of income tax) 2. Reduce in real value of gov debt 3. Real interest rate on borrowing might be neg if the nominal yield is less than the rate of inflation 4. Moderate inflation can lead to higher profit – more tax. |
| Economic issues w high inflation | 1. Cuts in real wages / incomes 2. Redistribution of income and wealth 3. Uncertainty and impact on investment |
| 2 reasons why relative inflation is costly | 1. Loss of price competitiveness for exporters – causing a slowdown or fall in export demand leading to weaker AD + negative effects for the trade balance, employment and capital investment 2. High relative inflation can cause exchange rate volatility – leading to currency depreciation which then increases import prices and lowers real living standards. More expensive for gov to borrow. |
| 2 reasons why inflation has a regressive effect | 1. spending patterns 2. real wage cuts |
| Wage price spiral | Where workers bid for higher wages by they’ve seen their real income eroded by fast rising prices. This can lead to a further burst of cost push inflation. |
| Policies to help inflation | Demand pull inflation: 1. Increases in interest rates and a tightening of the supply of credit 2. Contradictory fiscal policy – higher taxes and cuts in state spending Cost push inflation: 1. Supply side policies to increase productivity 2. Labour market reforms to increase labour supply |
| Supply side policies to help control inflation: | 1. Expansion of the workers visa programme to encourage more skilled workers into the up and from the EU and beyond. 2. Policies to encourage house building 3. Investment in human capital 4. Investment tax allowances 5. Infrastructure investment. |
| Reasons higher interest will cut inflation: | 1. Appreciation of the exchange rate – via inflow of hot money makes imports cheaper 2. Slower growth of ad – helps eliminate a positive output gap – less demand pull inflation 3. Wage inflation – reduced customer borrowing and spending may cause the labour market to soften – fall in job vacancies / perhaps leading t weaker wage growth. |
| Higher interest rates to control inflation: | 1. Increase in interest rates is a tightening of monetary policy 2. Should, in theory, lead to slower growth of aggregate demand 3. Helps to control demand pull inflation by closing the output gap 4. Can also lead to a stronger exchange rate 5. Leads to a drop in prices (costs)of imports. |
| Higher direct taxes to control inflation: | 1. Increase in direct tax is a deflationary fiscal policy 2. Higher taxes cause a drop in household disposable income 3. Consumers see a drop in their spending power 4. This feeds thru to weaker ad 5. Which will cause a fall in demand pull inflationary pressure |
| Reasons why inflation is so hard to control: | 1. Global economic factors 2. Supply side shocks 3. Built in inflation 4. Monetary policy lag |
| Benign (good) deflation | A fall in the price level due to increases due to as (usually due to falling costs of production |
| Malevolent (Bad) deflation – | Fall in the price level due to a fall in ad |
| Economic costs from deflation: | 1. Fall in wages 2. Real value of debt goes up 3. Consumers may hold back their spending 4. Investment may slump 5. Real interest rate on debt / savings will increase |
| Economic / business opportunities from a period of deflation | 1. Fall in general prices 2. Rise in demand for value products – businesses must offer value for money 3. Asset prices falling can improve housing affordability – imported for first time buyers |
| Asset price deflation | When the values of assets such as bonds, housing and equities fall over a sustained period. This often happens at the end of a financial bubble. |
| Economic impact of a period of deflation; | 1. Real interest rates rise 2. Real level of debt rises 3. Pressure for higher wages 4. Declining business profits 5. Rise in cyclical unemployment 6. Improved price competitiveness |
| Consequences of price deflation: | 1. Holding back on spending 2. Debts increase 3. Real cost of borrowing increases 4. Lower profit margins 5. Confidence and saving 6. Income distribution 7. Exporters become more competitive. |
| Economic policies to avoid price deflation: | 1. Low interest rates and quantitative easing 2. Fiscal stimulus measures 3. Other measures to stimulate ad |