Inflation

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  • Inflation
    • Measurement
      • CPI
        • A weighted index showing changes in the average cost of buying a basket of goods and services for a typical household
          • The CPI excludes payments on mortgage interest and is therefore usually lower than the RPI
      • RPI
    • Government Policy Responses
      • Fiscal
        • Controlling AD can reduce inflation when necessary
          • Reduce government expenditure
          • Raise direct taxes, reducing real disposable income so that consumption falls
      • Monetary
        • Introduction of a period of high interest to reduce consumer and investment spending
        • Higher value exchange rate causing imports to rise (M+) and exports to fall (X-)
      • Supply-Side
        • Increase productivity, competitiveness and innovation in order to maintain lower prices
        • Increase productivity to cause AS to shift outward, causing prices to fall
    • Causes
      • Demand-Pull
        • Occurs when AD is growing at an unsustainable rate leading to increased pressure on scarce resources. Firms are able to pull up prices and achieve bigger profit margins
          • Depreciation of exchange rate
          • Higher demand from fiscal stimulus
          • Fall in interest rates
          • Growth in Housing market
      • Cost-Push
        • Occurs when firm's cost of production rise. Firms then have to increase prices in order to stay in business
          • Rising labour costs
          • Higher indirect taxes
          • Monopoly employers
      • Internal
        • Decisions of utility or food companies to change prices can have a massive effect on inflation as these are necessities
        • Changes in VAT affect firms's costs, thus rising prices for goods and services
      • External
        • Fluctuations in the exchange rate can lead to higher import prices on goods such as foodstuffs from Western Europe or technology suppliers from the United States
    • UK Inflation
      • Inflation Target
        • Monetary Policy Committee's target of 2% per year using the CPI
      • Recent Trends
        • Steep rises in imported inflation caused by falling exchange rate and higher world prices
    • Consequences
      • Cost of Borrowing
        • High inflation may lead to high interest rates for businesses and people needing loans and mortgages as financial markets protect themselves against rising prices
      • Negative Real Interest Rates
        • Savers experience the real value of their savings to fall if inflation is higher than interest rates
      • Income Redistribution
        • There is a regressive effect on lower income families
      • Falling real incomes
        • Pay freezes coupled with inflation reduce the real value of income
    • Key Concepts
      • Inflation
        • A sustained increase in the general price level over a period of time
      • Purchasing Power
        • The ability to purchase goods and services. Purchasing power will fall as a result of inflation
      • Deflation
        • A decrease in prices or the cost of living over a period of time
      • Creeping Inflation
        • When inflation increases gradually over time
      • Hyperinflation
        • Inflation that occurs at an excessively high rate, usually over 100%
      • Rate of inflation
        • The annual percentage change in consumer prices
    • Hyperinflaton
      • Hyperinflation occurs when the value of money becomes worthless an people lose confidence
        • Zimbabwe, Brazil, Turkey, Weimar Germany

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