Download Inflation: Is it really all bad?

Inflation: Is it really all bad?
Mrs. Jeane McNamara
GVHS: SP 2002
What is Inflation?
• Sustained increase in price level
Is inflation all bad?
• Depends!--The key is that increases in real
wages must be > increase in the price level
What is impacted by inflation?
• Purchasing power: given a fixed sum of $,
what goods/services will it buy?
• Real wages: what is the purchasing power
of your wages
Does inflation erode wages?
• DEPENDS! Remember, REAL wages must be >
rate of inflation
• COLA--”Cost of Living Adjustment”--If the
COLA is tied to at or above inflation, the
wage earner is ok
Inflation does NOT...
• SYSTEMATICALLY erode purchasing power
(price changes could be tied to a specific
sector of the economy)
• DOES NOT lead to unfair prices
• SHOULDN’T be blamed when the price of one
good goes up relative to the price of
another good
Who is hurt by inflation?
• Lenders at fixed rates (lower than the rate of
inflation)
• Savers at fixed rates (lower than the rate of
inflation)
• Borrowers at variable rates (adjustable rates are
tied to inflationary indecies)
• Income earners at fixed wages (e.g.
contract/union workers)
Who is hurt by inflation?(con’t)
• Those individuals living on fixed incomes (NOTE:
SS does allow for a COLA, but it isn’t always tied to
the rate of inflation)
• Consumers, unless wages keep pace
Who is helped by inflation?
• Borrowers at fixed rates (lower than the rate of
inflation)
• Lenders at adjustable rates
Conclusions about inflation
• Inflation tends to arbitrarily redistribute
income
Interest rates and inflation
• The Real Rate of Interest = i-rate adjusted
for inflation = TRUE borrowing power
• The Nominal Rate of Interest = ‘expected’
interest rate + inflation = % i-rate borrower
pays lender not adjusted for inflation
Interest rates and taxes
• Our tax system was designed for an
inflation-free economy--taxes tax nominal
interest rates
• Conclusion: in periods of high inflation,
taxes penalize interest income because
our tax system doesn’t distinguish between
real and nominal interest rates
Interest rates and taxes (con’t)
• THEREFORE: Savings and Investment are
DISCOURAGED by our own tax system
Types of Inflation
• Creeping--Upward pressure on the price
level at a steady pace
• Bracket Creep--inflation pushing wage
earners into higher tax brackets
• Galloping--spikey increases (ex: post WWI
Germany, Latin countries)
Types of Inflation (con’t)
• Dis-inflation: a sustained period of little or
no inflation
• Deflation: sustained decreases in the price
level
How is the inflation rate
measured?
• Representatives from the Commerce Department
purchase the “market basket” of goods and
services to come up with a “Consumer Price
Index” (CPI)
• Economists like the “core inflation” measure--the
CPI with food and energy extracted
Problems with the CPI
• Often overstated as the market basket
doesn’t change in step with consumer
preference and/or regional demand
What’s the difference between “cost-push” and
“demand-pull” inflation?
• Demand-pull inflation is driven by
increased demand in the economy for
goods and services
• Cost-push inflation is driven by increased
costs of production