Download Inflation - Potomanto

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Inflation refers to a rising general level of
prices.
It does not mean that all prices are rising.
Even during periods of rapid inflation, some
prices may be relatively constant and others
falling.
The inflation rate is the percentage change in
the price level from the previous period.
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Inflation is measured using price indices such
as the Consumer Price Index (CPI), the
Producer Price Index (PPI), the GDP deflator
etc.
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒𝑐𝑢𝑟𝑟𝑒𝑛𝑡

𝐶𝑃𝐼𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 − 𝐶𝑃𝐼𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑝𝑒𝑟𝑖𝑜𝑑
=
∗ 100
𝐶𝑃𝐼𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑝𝑒𝑟𝑖𝑜𝑑
Inflation can be calculated on monthly or
yearly.
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A price index measures the combined price of a
particular collection of goods and services, called
“market basket” in a specific period relative to the
combined price of an identical (or highly similar)
group of goods and services in a reference period.
The consumer price index (CPI) is a measure of the
overall cost of the goods and services bought by a
typical consumer.
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The Ghana Statistical Service reports the CPI each
month as well as for the year.
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It is used to monitor changes in the cost of living over
time.
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When the CPI rises, the typical family has to
spend more cedis to maintain the same
standard of living.
In Ghana, the Consumer Price Index (CPI)
measures changes over time in the general
price level of goods and services that
households acquire for the purpose of
consumption, with reference to the price level
in 2012, the current base year, which has an
index of 100.
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Fix the Basket: Determine what prices are most
important to the typical consumer.
◦ The Ghana Statistical Service (GSS) identifies a market basket
of goods and services the typical consumer buys. The
consumer basket for Ghana is made up of the following:
CPI_Bulletin_2013_January.pdf
◦ The basket for Ghana now contains 267 consumer items,
after an update from a previous basket of 242 consumer
items.
◦ The GSS conducts consumer surveys to set the weights for
the prices of those goods and services. Weights are assigned
reflect the importance of the individual items being
combined.
16%
Food and
beverages
17%
Transportation
Education and
communication
41%
Housing
6%
6%
6% 4% 4%
Medical care
Recreation
Apparel
Other goods
and services
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Find the Prices: Find the prices of each of the
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Compute the Basket’s Cost: Use the data on
goods and services in the basket for each
point in time.
prices to calculate the cost of the basket of
goods and services at different times.
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Choose a Base Year and Compute the Index:
◦ Designate one year as the base year, making it the
benchmark against which other years are
compared. The base year for Ghana was 2002 but
was revised recently making 2012 the new base
year.
◦ Compute the index by dividing the price of the
basket in one year by the price in the base year and
multiplying by 100.
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Compute the inflation rate: The inflation rate
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The Inflation Rate
is the percentage change in the price index
from the preceding period.
◦ The inflation rate is calculated as follows:
CPI in Year 2 - CPI in Year 1
Inflation Rate in Year 2 =
 100
CPI in Year 1
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Assuming the consumer basket is made up of
2 bags of rice and 3 loaves of bread.
Supposing price of a bag of rice in 2003 was
Ghc15 and a loaf of bread was Ghp50.
In 2004, price of a bag of rice was Ghc20 and
a loaf of bread was Ghc1. Calculate the CPI
and inflation rate over the period, using 2002
as the base year.
In 2005, price of a bag of rice was Ghc21 and
price of a loaf of bread was Ghc1.2
Costs of the basket
 2003: 15(2) + 0.5(3)=31.5
 2004: 20(2) +
1(3)=43
 2005: 21(2) + 1.2(3)=45.5
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2003 CPI=(31.5/31.5) * 100 =100
2004 CPI=(43/31.5) * 100 =136.5
2005 CPI=(45.5/31.5)*100=144.8
Inflation was: 23% between 2003 and 2004,
and 30% between 2003 and 2005.
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Yearly inflation for 2004 was: 36.5%
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Yearly inflation for 2005 was:
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 2005
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144.8 − 136.5
=
× 100 = 6.1%
136.5
Note: Inflation rate fell from 36.5% to 6.1%.
As you can see, this does not mean that
prices are falling (contrary to the belief on the
airwaves!!!).
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The CPI is an accurate measure of the
selected goods that make up the typical
bundle, but it is not a perfect measure of the
cost of living.
◦ Substitution bias
◦ Introduction of new goods
◦ Unmeasured quality changes
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Substitution Bias
◦ The basket does not change to reflect consumer
reaction to changes in relative prices.
 Consumers substitute toward goods that have become
relatively less expensive.
 The index overstates the increase in cost of living by
not considering consumer substitution.
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Introduction of New Goods
◦ The basket does not reflect the change in
purchasing power brought on by the introduction of
new products.
 New products result in greater variety, which in turn
makes each cedi more valuable.
 Consumers need fewer cedis to maintain any given
standard of living.
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Unmeasured Quality Changes
◦ If the quality of a good rises from one year to the next,
the value of a cedi rises, even if the price stays the
same.
◦ If the quality of a good falls from one year to the next,
the value of a cedi falls, even if the price of the good
stays the same.
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The substitution bias, introduction of new
goods, and unmeasured quality changes
cause the CPI to overstate the true cost of
living.
◦ The issue is important because many government
programs use the CPI to adjust for changes in the
overall level of prices.
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The GDP deflator is calculated as follows:
Nominal GDP
GDP deflator =
 100
Real GDP
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The GSS calculates other prices indexes:
◦ The index for different regions within the country.
◦ The producer price index, which measures the cost
of a basket of goods and services bought by firms
rather than consumers.
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Economists and policymakers monitor both
the GDP deflator and the consumer price
index to gauge how quickly prices are rising.
There are two important differences between
the indexes that can cause them to diverge.
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The GDP deflator reflects the prices of all
goods and services produced domestically,
whereas...
…the consumer price index reflects the prices
of all goods and services bought by
consumers.
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The consumer price index compares the price
of a fixed basket of goods and services to the
price of the basket in the base year (only
occasionally does the GSS change the
basket)...
…whereas the GDP deflator compares the
price of currently produced goods and
services to the price of the same goods and
services in the base year.
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Headline Inflation vs Core Inflation
Headline inflation is inflation rate calculated using all the
items in the consumer baskets.
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Core inflation rate, is the CPI inflation rate excluding
volatile elements such as food and fuel.
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This is done in order to determine the trend in the
inflation rate.
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Inflation can also be calculated for different categories of
goods and services.
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For instance; Food inflation, Producer Inflation etc
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Demand-pull factors: factors that cause
excess of spending beyond economy’s
capacity to produce. Example is increase in
money supply, increase in general consumer
income.
Cost-push/supply side factors: These are
factors that raise per unit cost of production.
Rise in per unit cost of factors of production.
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Inflation causes redistribution of income. It
redistribute income between debtors and
creditors. Unexpected inflation benefits
debtors (borrowers) at the expense of
creditors (lenders).
Inflation hurts savers. It reduces the value of
fixed incomes. Examples include savings
accounts, insurance policies, annuities, and
other fixed-value paper assets.
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Price indexes are used to correct for the
effects of inflation when comparing dollar
figures from different times.
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Do the following to convert (inflate) a
worker’s annual income in 1990 to cedi
amount in 2014:
𝐶𝑃𝐼 𝑖𝑛 2014
𝑆𝑎𝑙𝑎𝑟𝑦2014 = 𝑆𝑎𝑙𝑎𝑟𝑦1990 ×
𝐶𝑃𝐼 𝑖𝑛 1990
177
= 80,000 ×
15.2
= 931,579
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When some cedi/dollar amount is
automatically corrected for inflation by law or
contract, the amount is said to be indexed for
inflation.
E.g. Labour unions include Cost-Of-Living
Adjustment clauses in contracts. Such
agreements automatically raise workers’
nominal incomes when inflation occurs.
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Interest represents a payment in the future
for a transfer of money in the past. It is the
cost of capital.
Commercial Banks’ Lending rate
Deposit rate
Policy rate
Treasury bill rate
Etc.
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The nominal interest rate is the interest rate
usually reported and not corrected for
inflation.
◦ It is the interest rate that a bank pays.
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The real interest rate is the nominal interest
rate that is corrected for the effects of
inflation.
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You borrowed Ghc1,000 for one year.
Nominal interest rate was 15%.
During the year inflation was 10%.
Real interest rate = Nominal interest rate –
Inflation
= 15% - 10% = 5%
Interest Rates
(percent
per year)
15
10
Nominal interest rate
5
0
Real interest rate
–5
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