INTRODUCTION
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In economics, inflation is a rise in the general level of prices of goods and
services in an economy over a period of time.[1] When the general price level
rises, each unit of currency buys fewer goods and services. Consequently,
inflation also reflects an erosion in the purchasing power of money – a loss
of real value in the internal medium of exchange and unit of account in the
economy.[2][3] A chief measure of price inflation is the inflation rate, the
annualized percentage change in a general price index (normally the
Consumer Price Index) over time.[4]
Inflation's effects on an economy are various and can be simultaneously
positive and negative. Negative effects of inflation include a decrease in the
real value of money and other monetary items over time, uncertainty over
future inflation may discourage investment and savings, and high inflation
may lead to shortages of goods if consumers begin hoarding out of concern
that prices will increase in the future. Positive effects include ensuring
central banks can adjust nominal interest rates (intended to mitigate
recessions),[5] and encouraging investment in non-monetary capital
projects.
INTRODUCTION
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Inflation is usually estimated by calculating the inflation rate of a price
index, usually the Consumer Price Index.[26] The Consumer Price Index
measures prices of a selection of goods and services purchased by a "typical
consumer".[4] The inflation rate is the percentage rate of change of a price
index over time.
For instance, in January 2007, the U.S. Consumer Price Index was 202.416,
and in January 2008 it was 211.080. The formula for calculating the annual
percentage rate inflation in the CPI over the course of 2007 is
The resulting inflation rate for the CPI in this one year period is 4.28%,
meaning the general level of prices for typical U.S. consumers rose by
approximately four percent in 2007.[27]
TYPES OF INFLATION
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There are different types inflation which are explained below:
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Creeping Inflation: This is also known as mild inflation or moderate inflation. This type
of inflation occurs when the price level persistently rises over a period of time at a mild
rate. When the rate of inflation is less than 10 per cent annually, or it is a single digit
inflation rate, it is considered to be a moderate inflation.
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Galloping Inflation: If mild inflation is not checked and if it is uncontrollable, it may
assume the character of galloping inflation. Inflation in the double or triple digit range of
20, 100 or 200 percent a year is called galloping inflation . Many Latin American countries
such as Argentina, Brazil had inflation rates of 50 to 700 percent per year in the 1970s and
1980s.
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Hyperinflation: It is a stage of very high rate of inflation. While economies seem to
survive under galloping inflation, a third and deadly strain takes hold when the cancer of
hyperinflation strikes. Nothing good can be said about a market economy in which prices
are rising a million or even a trillion percent per year . Hyperinflation occurs when the
prices go out of control and the monetary authorities are unable to impose any check on it.
Germany had witnessed hyperinflation in 1920’s.
TYPES OF INFLATION
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Stagflation: It is an economic situation in which inflation and
economic stagnation or recession occur simultaneously and remain
unchecked for a period of time. Stagflation was witnessed by
developed countries in 1970s, when world oil prices rose
dramatically.
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Deflation: Deflation is the reverse of inflation. It refers to a
sustained decline in the price level of goods and services. It occurs
when the annual inflation rate falls below zero percent (a negative
inflation rate), resulting in an increase in the real value of money.
Japan suffered from deflation for almost a decade in 1990s.
METHODS FOR CALCULATING INFLATION
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Producer price indices (PPIs) which measures average changes in prices received
by domestic producers for their output. This differs from the CPI in that price
subsidization, profits, and taxes may cause the amount received by the producer
to differ from what the consumer paid. There is also typically a delay between
an increase in the PPI and any eventual increase in the CPI. Producer price
index measures the pressure being put on producers by the costs of their raw
materials. This could be "passed on" to consumers, or it could be absorbed by
profits, or offset by increasing productivity. In India and the United States, an
earlier version of the PPI was called the Wholesale Price Index.
Commodity price indices, which measure the price of a selection of commodities.
In the present commodity price indices are weighted by the relative importance
of the components to the "all in" cost of an employee.
Core price indices: because food and oil prices can change quickly due to
changes in supply and demand conditions in the food and oil markets, it can be
difficult to detect the long run trend in price levels when those prices are
included. Therefore most statistical agencies also report a measure of 'core
inflation', which removes the most volatile components (such as food and oil)
from a broad price index like the CPI. Because core inflation is less affected by
short run supply and demand conditions in specific markets, central banks rely
on it to better measure the inflationary impact of current monetary policy.
COMMON MEARURES OF INFLATION
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GDP deflator is a measure of the price of all the goods and services included in
gross domestic product (GDP). The US Commerce Department publishes a
deflator series for US GDP, defined as its nominal GDP measure divided by its
real GDP measure.
Regional inflation :The Bureau of Labor Statistics breaks down CPI-U
calculations down to different regions of the US.
Historical inflation :Before collecting consistent econometric data became
standard for governments, and for the purpose of comparing absolute, rather
than relative standards of living, various economists have calculated imputed
inflation figures. Most inflation data before the early 20th century is imputed
based on the known costs of goods, rather than compiled at the time. It is also
used to adjust for the differences in real standard of living for the presence of
technology.
Asset price inflation is an undue increase in the prices of real or financial assets,
such as stock (equity) and real estate. While there is no widely accepted index of
this type, some central bankers have suggested that it would be better to aim at
stabilizing a wider general price level inflation measure that includes some asset
prices, instead of stabilizing CPI or core inflation only. The reason is that by
raising interest rates when stock prices or real estate prices rise, and lowering
them when these asset prices fall, central banks might be more successful in
avoiding bubbles and crashes in asset prices.[
Inflation
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This is the process by which the price level rises
and money loses value.
There are two kinds of inflation:
a) Demand pull
b) Cost push
Demand pull inflation
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a)
b)
c)
Demand pull inflation may be due to :
Increase in money supply
Increase in government purchases
Increase in exports
Cost push
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a)
b)
Cost push inflation may arise because of :
Increase in money wage rates
Increase in money prices of raw materials.
Discussion question
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Why is inflation bad?
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a)
b)
Unanticipated inflation is bad because it makes the
economy behave like a giant casino.
Gains and losses occur because of unpredictable
changes in the value of money.
If the value of money varies unpredictably over time,
the quantity of goods and services that money will buy
will also fluctuate unpredictably.
Resources are also diverted from productive activities
to forecasting inflation.
Unanticipated inflation leads to :
Redistribution of income, borrowers and lenders
Too much or too little lending or borrowing
CPI
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Consumer Price Index (CPI) is one of the most frequently
used statistics for identifying periods of inflation or
deflation.
Large rises in CPI during a short period of time typically
denote periods of inflation.
The U.S. Bureau of Labor Statistics measures two kinds
of CPI statistics:
 CPI for urban wage earners and clerical workers (CPIW),
 The chained CPI for all urban consumers (C-CPI-U).
Of the two types of CPI, the C-CPI-U is a
better representation of the general public, because it
accounts for about 87% of the population.
The CPI uses a base year and indexes current year
prices based on the base year's values.
Headline Inflation
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The raw inflation figure as reported through the
Consumer Price Index (CPI) that is released monthly
by the Bureau of Labor Statistics.
Also known as "top-line inflation".
The headline figure is not adjusted for seasonality or
for the often-volatile elements of food and energy
prices.
Inflation is usually quoted on an annualized basis.
A monthly headline figure of 4% inflation equates to a
monthly rate that, if repeated for 12 months, would
create 4% inflation for the year.
Comparisons of headline inflation are typically made
on a year-over-year basis.
Core Inflation
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While headline inflation tends to get the most
attention in the media, core inflation is often
considered the more valuable metric to follow.
Core inflation removes the CPI components that can
exhibit large amounts of volatility month to month,ie
those that can have temporary price shocks .
Core inflation usually excludes energy and food
products.
Other methods of calculations include the outliers
method.
The products that have had the largest price changes
are taken out.
Hyper inflation
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Extremely rapid or out of control inflation.
There is no precise numerical definition to hyperinflation.
Price increases are so out of control that the concept of
inflation is meaningless.
The most famous example of hyperinflation occurred in
Germany between January 1922 and November 1923.
By some estimates, the average price level increased by a
factor of 20 billion!
Stagflation
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A condition of slow economic growth and relatively high
unemployment accompanied by inflation.
This happened to a great extent during the 1970s, when
world oil prices rose dramatically, fueling sharp inflation in
developed countries.
Are we seeing that about to happen in early 2008?
At least some central banks have expressed concern over
inflation even as the global economy seems to be slowing
down.
Unemployment and the labour force
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Labour force or workforce - The number of people
employed and self-employed plus those
unemployed but ready and able to work.
Three factors affect the size of the labour force:
 Population
 Migration
 Labour force participation in economic activity.
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The Keynesians and the Monetarists
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Keynesians, assumed that the economy would always have
some slack.
The government could lower the rate of unemployment if it
was willing to accept a little more inflation.
However, economists such as Milton Friedman argued that
the economy of left to itself would adjust to full employment.
The supposed inflation-for-jobs trade-off was in fact a trap.
Governments that tolerated higher inflation in the hope of
lowering unemployment would find that joblessness dipped
only briefly before returning to its previous level, while
inflation would rise and stay high.
Instead, they argued, unemployment has an equilibrium or
natural rate, determined not by the amount of demand in an
economy but by the structure of the labour market.
They stressed the importance of flexible labour markets.
Core inflation data
Commodity price data