"Inflation" is our topic for today, but we'll do a couple things off the top here first.
I'll return the quizzes that I have so that you can take a look at them.
Wachovia College Budgeting Calculator: Anything interesting come up here?
Naked Economics - Chapter 5: You were asked to have this read for today. I think this is one of the most interesting chapters, and I am curious as to what you found the most interesting.
Fiscal v. Monetary
Policy - Let's make sure you
understand the basics of these two concepts, since we'll come back to them
again and again.
Inflation: We'll be looking at inflation today, since it might be the economic issue of most concern to policymakers and consumers. (I suppose that would be more true when the economy isn't facing its most serious challenges since the Great Depression...) This topic will come up several times, but we'll get some of the basics out of the way.
Defining "inflation": Inflation is a sustained increase in the overall level of prices. The most widely reported measurement of inflation is the consumer price index (CPI).
The Consumer Price Index measures prices of goods and services in a market basket of goods and services that is intended to be representative of a typical consumer's purchases. The percentages currently used to describe the categories of goods and services that market basket are as follows.
- Food and beverages 15 %
- Recreation 6 %
- Housing 42 %
- Education 3 %
- Clothing 4 %
- Communication 3 %
- Transportation 17 %
- Medical care 6 %
- Other goods and services 4 %
Inflation and the CPI, April 16, 2008 - This is the text of the most recent inflation report from the National Council on Economic Education. We can take a look at some of the graphs and charts for a minute.
Much of the following information is simply copied from the EconEd website for our convenience in class today...
Causes of Inflation: Over short periods of time, inflation can be caused by a decrease in production or an increase in spending. We get the names for the two major types from this: demand-pull and cost-push.
Inflation resulting from an increase in aggregate demand or total spending is called demand-pull inflation. Increases in demand, particularly if production in the economy is near the full-employment level of real GDP, pull up prices. It is not just rising spending. If spending is increasing more rapidly than the capacity to produce, there will be upward pressure on prices.
Inflation can also be caused by increases in costs of major inputs used throughout the economy. This type of inflation is often described as cost-push inflation. Increases in costs push prices up. The most common recent examples are inflationary periods caused largely by increases in the price of oil. Or if employers and employees begin to expect inflation, costs and prices will begin to rise as a result.
Over longer periods of
time, that is, over periods of many months or years, inflation is caused by
growth in the supply of money that is above and beyond the growth in the demand
for money.
Living with Inflation: We'll do a quick activity here looking at the effects inflation had on the former Soviet Union and its neighbors in the years after the fall of the Berlin Wall and the shift to market economies.
The Costs of Inflation: Here's one short summary of some of the costs of inflation.
- High rates of inflation mean that people and business have to take steps to protect their financial assets from inflation. The resources and time used to do so could produce goods and services of value.
- High rates of inflation discourage businesses planning and investment as inflation makes the forecasting of prices and costs more difficult. As prices rise, people need more dollars to carry out their transactions. When more money is demanded, interest rates increase.
- The adage "inflation hurts lenders and helps borrowers" only applies if inflation is not expected. For example, interest rates normally increase in response to anticipated inflation. As a result, the lenders receive higher interest payments, part of which is compensation for the decrease in the value of the money lent. Borrowers have to pay higher interest rates and lose any advantage they may have from repaying loans with money that is not worth as much as it was prior to the inflation.
- Inflation does reduce the purchasing power of money.
- Inflation does redistribute income. On average,
individuals' incomes do increase as inflation increases. However, some
peoples' wages go up faster than inflation. Other wages are slower to
adjust. People on fixed incomes such as pensions or whose salaries are
slow to adjust are negatively affected by unexpected inflation.
Questions to consider: We'll get to them in a few days...
- How does the US government work to prevent and/or control inflation?
- What level of inflation should we aim for?
For one perspective on that issue, here's what Alan Greenspan had to say at a 1989 Congressional hearing:
"Maximum sustainable economic growth over time is the U.S. Federal Reserve's ultimate objective. The primary role of monetary policy in the pursuit of this goal is to foster price stability. For all practical purposes, price stability means that expected changes in the average price level are small enough and gradual enough that they do not materially enter business and household financial decisions."
Maybe a "non-answer," but it seems to translate into a 2 or 3 percent rate in practice.
HOMEWORK for tomorrow - Thursday, November 20th
Your Blog Entry #5 should be posted before the start of class time on Friday.
Please have Chapter #6 of Naked Economics, "Productivity and Human Capital," read for Monday's class.
