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Inflation • A general increase in the price level. • A decline in the value of money. • “Too many dollars chasing too few goods.” Types of Inflation • Demand Pull – Resources are fully employed – Businesses cannot respond to new demand by expanding output – Excess demand bids up the prices of the limited output – Total spending pulls up prices – “too much money chasing too few goods” – Can be persistent Types of Inflation • Cost Push – – – – – – – (supply side) Rising per unit production cost Firms willing/able to supply less at price Supply shocks Rising cost of Factors of Production pushes up prices Wage – Price Spiral Symptom of something gone wrong Self-limiting – causes recessions Types of Inflation Hyper-Inflation Very high rate of inflation. • Money loses value very quickly. • Money becomes worthless. Causes Currency is printed to pay government obligations / debts. • Germany between WWI & WWII (322% per month in 1922-23) Zimbabwe inflation hits 11,200,000 percent .cnn August 19, 2008 • Zimbabwe's inflation rate has soared in the past three months and is now at 11.2 million percent, the highest in the world, according to the country's Central Statistical Office. Official figures dated Monday show inflation has surged from the rate of 2.2 million percent recorded in May, despite the government's price controls. In February, the price of a loaf of bread in the country was less than 200,000 Zimbabwe dollars. On Monday, that same loaf of bread cost 1.6 trillion Zimbabwe dollars Zimbabwe's $100 billion banknote with the number of eggs it could purchase on its release date. Zimbabwe's $100 billion banknote with the number of eggs it could purchase on its release The dollar was effectively abandoned as an official currency on 12 April 2009. Companies and individuals are permitted to transact domestic business in other currencies, such as the US dollar or the South African rand. Country Hungary Zimbabwe Yugoslavia Germany Greece China Month with Highest highest monthly inflation inflation rate rate July 1946 MidNovember 2008 (latest measurable) January 1994 October 1923 November 1944 May 1949 1.30 x 1016% Equival ent daily inflatio n rate 195% Time required for prices to double 15.6 hours 79,600,000,000 % 98.0% 24.7 hours 313,000,000% 64.6% 1.4 days 29,500% 20.9% 3.7 days 11,300% 17.1% 4.5 days 4,210% 13.4% 5.6 days Deflation • • • • A decline in the price level Unusual in the U.S. economy Happens during a severe contraction. Significant declines in prices – After the Great War 1921 -1922 – Great Depression 1927 – 1933 & 1938 - 1939 • Last time we had a yearly decline 2009 Measures of Inflation • Price Indexes – CPI = Consumer Price Index – PPI = Producer Price Index – GDP Deflator Price index • Market basket – Price of the good/service – Weighted – frequency of purchase • Index or base = 100 Measures of Inflation Price Indexes • Consumer Price Index – Market basket of goods (95,000) – Many retail establishments (23,000) – Cities (87) Education 6.4% Other 3.5% Food and Beverage 14.8% Recreation 6.3% Medical Care 6.6% 1 2 3 4 5 6 7 Transportation 17.3% Apparel 3.6% Housing 41.5% 8 Consumer Price Index Inflation since Jan 2001 Last 50 years Inflation Since 1914 Inflation & CPI Year Inflation 1 CPI 100 2 10% 110 3 10% 121 4 10% 133.1 October 2010 CPI – Selected Sectors (1982-84 = 100, June 1983 = 100) All items 226.421 Food & Beverages Housing 230.885 220.138 Apparel 127.590 Transportation Medical Care 212.127 403.430 Tuition 611.458 Tobacco 842.785 8.882 Info Tech (12/88 = 100) October 2009 CPI – Selected Sectors (1982-84 = 100, June 1983 = 100) All items 216.177 Food & Beverages Housing 217.957 216.612 Apparel 123.998 Transportation Medical Care 185.362 378.552 Tuition 563.352 Tobacco 773.758 9.501 Info Tech (12/88 = 100) October 2008 CPI – Selected Sectors (1982-84 = 100, June 1983 = 100) All items 216.573 Food & Beverages Housing 218.705 217.383 Apparel 122.243 Transportation Medical Care 192.709 365.746 Tuition 537.606 Tobacco 599.744 9.874 Personal Computers Inflation redistributes income • Key is real income – The amount of goods and services money buys • If your nominal income keeps pace with inflation your real income doesn’t change • If inflation is expected or anticipated can adjust • COLA cost of living adjustment Anticipated Inflation • Inflation is not as serious IF we prepare for it – IF we adjust nominal income to expect price increases – IF lenders adjust nominal interest rate by charging an “inflation premium” Real Interest Rate + Inflation Premium (expected inflation) = Nominal Interest Rate Hurt by Unanticipated Inflation • Fixed Income recipients – Retired people on pensions • Savers – Interest rates often lower than inflation • Creditors – Repaid in dollars that are worth less Helped by Unanticipated Inflation • Flexible Income receivers – COLAs – Social Security – indexed to CPI – Commission sales • Debtors – Lender factors in an inflation premium – If inflation is higher than anticipated Philips Curve • Inflation and Unemployment are inversely related • Trade-off for Policy Makers – Fight Unemployment by increasing Inflation – Fight Inflation by increasing Unemployment Inflation High Inflation Low Unemployment Low Inflation High Unemployment Unemployment How has inflation affected the value of a dollar? • Todays Dollar $1.00 • Purchases (is worth) .442 of 1982-84 $ .147 of 1967 $