© VAN SCHAIK PUBLISHERS
Chapter 20:
Inflation
Learning outcomes
Once you have studied this chapter, you should be able to
• define inflation
•
distinguish between different measures of inflation
•
Calculate CPI
•
explain why inflation is regarded as a problem
•
Explain, using diagrams, the difference between demand-pull
and cost-push inflation;
•
Identify the factors that give rise to demand-pull and cost-push
inflation
•
Explain “inflation targeting” as a policy measure that can be used
to combat inflation
© VAN SCHAIK PUBLISHERS
Definition of inflation
Continuous and considerable rise in prices in general.
• Four important aspects
•
•
Neutral definition (does not mention causes)
• does not attempt to define inflation in terms of specific
causes.
• Causal in nature eg. To much money circulating.
Continuous rise in prices – process
• Inflation refers to a process of prices increasing annually.
© VAN SCHAIK PUBLISHERS
Definition of inflation
Continuous and considerable rise in prices in general.
• Four important aspects
•
•
Considerable increase in prices
• 1% / 2% considerable? May product’s quality cause this rise
or inflation?
General price level increase
• Not item specific but general prices of most goods and
services
© VAN SCHAIK PUBLISHERS
Measurement of inflation
• CPI- most common indicator of the general price level
• index of price of basket of G & S, not a rate
• percentage change in the CPI from one period to the next =
inflation rate.
• therefore calculate the rate of change in CPI
• Month on same month of previous year
(CPI current period - CPI last period) X
CPI last period
100
• Year on year (annual average on annual average)
© VAN SCHAIK PUBLISHERS
The measurement of inflation
• The consumer price index
– Month on the same month during the previous year
(CPI current period - CPI last period) X
CPI last period
100
Table 20-1 The consumer price
index and inflation in South
Africa 2012–2013
(Textbook page 383)
© VAN SCHAIK PUBLISHERS
The measurement of inflation
• The consumer price index
– Annual average on annual average
(CPI annual average current period - CPI annual average last period) X
CPI annual average last period
100
Table 20-1 The consumer price
index and inflation in South
Africa 2012–2013
(Textbook page 383)
© VAN SCHAIK PUBLISHERS
The measurement of inflation
• The producer price index
Table 20-2 Main differences between the CPI and PPI
(Textbook page 383)
© VAN SCHAIK PUBLISHERS
The measurement of inflation
The producer price index
Table 20-3 Annual
rates of increase in
CPI and PPI, 2013
(Textbook page 384)
• The implicit GDP
deflator
© VAN SCHAIK PUBLISHERS
The effects of inflation
• Distribution effects
• some individuals or groups lose while others benefit
• who lose and who win?
• debtors tend to gain at the expense of creditors
• young tend to gain at the expense of elderly
• government tends to gain at expense of private sector
• Economic effects
• impact on employment and growth
• productive activity neglected
• saving discouraged
• exports may suffer
• imports may be stimulated
© VAN SCHAIK PUBLISHERS
The effects of inflation
• Social and political effects
•
•
people unhappy
social and political unrest may ensue
Box 20-1 The destructive power of inflation (Textbook page 386)
Box 20-2 Falling prices: a consumer’s heaven? (Textbook page 387)
• Expected inflation
•
•
•
inflation may result in the expectation of further inflation
self-fulfilling prophesy
may give rise to hyperinflation
Box 20-3 Hyperinflation (Textbook page 387)
© VAN SCHAIK PUBLISHERS
The causes of inflation
• Demand-pull and cost-push inflation
– Demand-pull inflation
• Prices “pulled up” by increase
in aggregate demand
• Could be the result of any
or combination of components
AD- C, I, G, X
• usually accompanied by
increase in M (money stock)
• Price level P increases
• Production and income (Y) also
increases (up to full employment)
• MP may be used to min inflation
Figure 20-1 Demand-pull inflation (Textbook page 389)
© VAN SCHAIK PUBLISHERS
The causes of inflation
• Demand-pull and cost-push inflation
– Cost-push inflation
• Prices pushed up by increase
in costs to producers
• Price level P increases
• Production and income (Y) also
Decreases (stagflation)
• Sources of cost push
•
•
•
•
•
increased wages and salaries
increased cost of imported capital and intermediate goods
increased profit margins
decreased productivity
natural disasters
Figure 20-2 Cost-push inflation (Textbook page 390)
© VAN SCHAIK PUBLISHERS
The causes of inflation
• The structuralist approach to inflation
inflation process is the result of the interaction between:
– Underlying factors
– Background (root) against which the inflation process occurs
– Initiating factors
– which trigger or intensify a particular inflation process
– Propagating factors
– which transmit the initiating impulse(s) through the economy
and over time
– To explain inflation, all three sets of factors have to be
taken into account AND have to be present.
© VAN SCHAIK PUBLISHERS
The causes of inflation
• The structuralist approach to inflation
– Table 20-4 Underlying, initiating and propagating
factors in the inflation process (Textbook page 391)
© VAN SCHAIK PUBLISHERS
The causes of inflation
• The conflict approach to inflation
Figure 20-3 A simplified view of the conflict approach
(Textbook page 394)
© VAN SCHAIK PUBLISHERS
Anti-inflation policy
• The costs of anti-inflation policy
• Depends on the type of inflation being experienced
• Demand-pull inflation VS Cost-push inflation
• Demand-pull inflation
• use restrictive monetary and fiscal policy
• P decreases but Y also decreases
• trade-off situation
© VAN SCHAIK PUBLISHERS
Anti-inflation policy
• The costs of anti-inflation policy
• Depends on the type of inflation being experienced
• Demand-pull inflation VS Cost-push inflation
• Cost-push inflation
• cannot use restrictive monetary and fiscal policy
• restrictive policy would increase unemployment
further
• ideal is to increase supply
• difficult in practice
• cannot use restrictive monetary and fiscal policy
© VAN SCHAIK PUBLISHERS
Anti-inflation policy
• Indexation
• means that prices, wages, pensions and so on are
linked to price indices (for example, the CPI) to
eliminate the distribution effects of inflation.
• Trade-off in that todays prices serves as a basis for
tomorrows price increases.
• Should be used only in emergency conditions.
© VAN SCHAIK PUBLISHERS
Anti-inflation policy
• Inflation targeting
– The key features are thus:
• the announcement of quantitative targets
• primacy of price stability as the objective of monetary
policy
• a broad-based, pragmatic approach to the analysis of
inflation
• transparency
• accountability
© VAN SCHAIK PUBLISHERS
Important concepts
•
•
•
•
•
•
•
•
•
•
•
•
Inflation
Consumer price index
Headline inflation
Producer price index
GDP deflator
Distribution effects
Real interest rate
Bracket creep
Fiscal dividend
Economic effects
Social and political effects
Hyperinflation
•
•
•
•
•
•
•
•
•
•
•
•
Deflation
Demand-pull inflation
Cost-push inflation
Stagflation
Incomes policy
Underlying factors
Initiating factors
Propagating factors
Conflict approach
Effective claims
Indexation
Inflation targeting
© VAN SCHAIK PUBLISHERS