Inflation

Last updated Sep 12, 2023 Edit Source

Inflation Definition Persistent and appreciable rise in the general or average level of prices over time.

• Inflation is measured by the Consumer Price Index (CPI):
  • Weighted index based on proportion of income spent
• Measures the change in price
• Inflation rate: $\frac{CPI (Y2) - CPI (Y1)}{CPI(Y1)}*100$

• Headline measure (CPI): Measure reported by the media
• Underlying measure: Inflation the best reflects market forces

Trimmed mean

• Remove the most volatile 15% of items from each side of the CPI Weighted median
• Change in middle 50th percentile by weight CPI excluding volatile items
• Which is the average inflation rate of all items in the CPI except for fruit, veg and fuel as they are very volatile
• Always removes the same items

• Only reports price movements in metro areas
• Does not account for quality of goods and services
• Not regarded as “true” cost of living index
  • Does not reflect changing consumer preferences on a daily basis

• Excess of aggregate demand over aggregate supply at the full employment of resources
• Rise in the general price level resulting from an excess of demand over supply
• Will push wage prices up with higher demand for labour

• Caused by a fall in aggregate supply, resulting from an increase in wages or prices of other inputs
• Rise in production costs are passed on to consumers who have to pay higher prices for final goods and services

• Reduces real income
  • Buy less goods with same money
• Affects interest rates
  • Real interest rates must be positive for lenders to make a profit and lend
• International competitiveness
  • Country’s exports at disadvantage when domestic inflation is greater than overseas
• Currency depreciation
  • Less overseas demand for country’s goods
• Capital for labour substitution
  • Due to wage inflation and structural change
• Uncertainty for decision makers
  • Investment decisions, reduce output and employment opportunities
• Economic efficiency
  • People move away from productive to speculative activities (assets, investment): negative impact on economic output
• Hyperinflation (above 30% p.a.)
  • Diversion of efforts towards hoarding or non-productive activities
• Increase in income inequality
  • Bracket creeps: As income rises with inflation, higher margin of tax leading to fewer tax brackets

• Helps maintain low real interest rates
  • Supports economic confidence
  • Encourages higher levels of consumption and investment
• Creates confidence about growth of economy
  • Assets like houses will increase in value over time
  • Changes in prices are predicable, allowing consumers/producers to comfortably make long term decisions