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INFLATION
LO 4
1
LO4 AS1: Analyse and investigate inflation and explain
he policies hat are used to combat it.
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Definition of inflation
- is sustained and significant increase
- in the general price level
- over a period of time
- results in a decrease in the buying power of money
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Characteristics of inflation
- it is not a once price rise but a continuous process of
price increases
- refers to a rise in prices in general than in one or more
products
- it is concerned with a considerable increase in prices
- causes a decline in the purchasing power and value of money
KINDS OF INFLATION
 Two main types of inflation
 Demand-Pull Inflation
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Demand for goods is higher than the supply
Or demand increases much faster than supply
Which results in price increases
Aggregate demand increases an this pulls up the
prices
 Cost-Push Inflation
 Caused by an increase in the production costs
 The increased price pushes up the price level
 Eg. The increase in wages, Increase in fuel prices etc
OTHER TERMS/CONCEPTS
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Hyperinflation
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Stagflation
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Most extreme form of inflation
Defined as runaway inflation
During this condition the national currency is worth almost nothing and
the exchange of goods for goods and not for money is widespread
When both the inflation and unemployment rate increases
This occurs in economies that lose the ability to create new jobs
Here economic growth is stagnated because of strong monetary and
fiscal policy to cub inflation
Deflation
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This a continuous decrease in prices and a simultaneous increase in the
purchasing (buying) power of money
This a deliberate attempt to decrease demand, production and prices
This is a result of a strict monetary and fiscal policy to decrease the
inflation rate
How inflation is measured
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Consumer Price Index (CPI)
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CPIX (CPI excluding interest rates on mortgage bonds)
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This reflects the cost of a representative basket of consumer goods and
services.
This shows how the average price level of goods and services bought
by a household/consumer changes over time
The inflation rate is the annual percentage change in the CPI
Derived by excluding interest rates on mortgage bonds from the basket
of goods and services used to compile the CPI
Production Price Index (PPI)
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The PPI measures prices at the level of the first significant commercial
transaction
The prices of imported goods are measured at the point of entry to a
country and not when they are sold
Likewise, manufactured goods are priced when the leave the factory
The PPI, like CPI, is estimated and published on a monthly basis by
Stats SA, but it measures the cost of production rather than the cost of
living
THE CAUSES OF INFLATION
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Increase in the money supply
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Excessive extension of credit may lead to increase in the demand
for G and S
If there is no increase in supply of these G and S a shortage will
occur
“Too much money chasing too few goods
Demand will pull the prices of G and S upwards
Increase in the input costs
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When input costs increase, the selling price of these goods will
increase
Costs will therefore push prices upward
If there is no increase in production this will result in cost-push
inflation
THE CAUSES OF INFLATION (Cont)
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Market failures
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Inflation occur when the normal interaction between demand and
supply is not in balance
If D and S is not in equilibrium it will result in a change in the price
of consumer G and S
If D > S then prices will increase
Weaker exchange rates
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If SA has a weaker exchange rate it will be more expensive for
people in SA to buy G and S.
The price of these goods imported will increase.
This is called imported inflation
THE CAUSES OF INFLATION (Cont)
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Decline in productivity
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In a free market economic, workers are paid based on
productivity’
Should salaries and wages increase with an increase in
productivity, prices will increase to compensate for the loss
Trade Unions
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Excessive wage demands will increase cost-push inflation
If demands are not met resulting in strikes and lower productivity
Shortages occur in the market resulting in higher prices.
Consequences of Inflation
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A decrease in the buying power of the currency
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An increase in poverty levels
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Most important consequence of inflation
Consumer buys less with the same amount of money
More Rands to be given for the same product
Poverty levels increase because money is worth less and they
can buy less G and S
People are unable to buy and satisfy their basic needs.
Lead to lower living conditions and increased poverty levels
People dependent on a fixed income
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People with fixed income are hit hard by inflation (Pensioners)
It decreases their realm income
Low-income workers cannot keep pace with inflation
Inflation impoverishes these workers
Consequences of Inflation
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Psychological influence
This normally influences investor confidence in the country
Consumers tend to spend more when they become aware that
prices may increase (Purchasing power decreases)
 This may lead to higher prices due to demand pulling prices
higher
Negative influence on savings
 If the interest on savings is less than the inflation rate the real
value of money decreases
 Investors will be worse off if they save
 On the other hand people paying loans will benefit because
they pay less than they borrowed
 This may interest to rise.
Increased unemployment
 Higher inflation rate higher unemployment
 Higher prices decrease in demand for G an S
 Production levels decrease
 Business may therefore decrease staff to compensate
Production losses
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Consequences of Inflation
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Balance of payments problems
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Trade between countries effect the prices levels in one of these
countries
If the inflation rate in SA increases then it will be difficult to sell our
products – becomes too expensive
SA exports will decrease and shortages will occur on the BOP (M
will increase)
Increase in tax income for government
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Higher inflation, higher salaries and wages, resulting in higher
personal tax to the state.
If tax brackets are not adjusted, then people will pay higher
taxes
Business compensate workers with higher wages because of
higher seller prices leading to higher profit margins on which
businesses pay tax.
The Inflation problem in South Africa
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Short term problems
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Demand
Production capacity
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Borrowing
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Household debt as a % to disposable income has increased over the
years and this indicates an increase in demand
Sales of durable goods
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The MPC uses increases in the GDP as a way to calculate level of
demand and employment
If manufacturers have little capacity to increase output and
employment, inflationary pressures develop
Increase in motorcar sales and an increase in house prices
Strong domestic demand
Money supply and credit
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M3 increased from 2004 by 18% to 19%, whilst bank loans to the
private sector grew by 20%
The Inflation problem in South Africa
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Cost
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World inflation
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Labour costs
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Theses prices wee below inflation, the cost of education has been
slightly higher
Market prices
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Key inputs such as fuel plays a role in increasing or slowing inflation
Administered prices
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Wage settlements were in most years below productivity increases
Key inputs
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If the rate is higher it puts pressure on domestic prices
If it is lower it reduces the pressure on inflation
Goods such as food, clothing, medical aid, etc are continuously
mentioned by the MPC
Exchange rates
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These rates have not yet stablised. They still fluctuate
The Inflation problem in South Africa
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Long-term problems
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Logistical infrastructure
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Asgisa announced a plan to spend on physical infrastructure
In the meantime there is inadequate port capacity, airport limitations,
rail cargo and road restrictions and congestion
Energy
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Liquid fuels, fuel stock and electricity (Costs, capacity and disruptions)
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Private and public sectors have severe shortages of skilled and highly
skilled workers
Too much red tape to recruit skills from abroad
Escalations in the costs of labour
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Increased deficit financed by loans from abroad
These investments may be repaid quickly “hot money”
Thus rand will depreciate (too much Rands in circulation)
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Increase social spending, especially on cash grants
Taxes for this has been increased
Increases in taxes fuel inflation
Skilled labour
Exchange rate depreciation
Social spending
Inflation – Combating measures
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Fiscal Measures
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Steps taken through policies for taxation and expenditure
 If there is excessive demand, this can be lessen by increasing
direct taxation – personal income tax
 Indirect taxation – VAT, customs and excise duties can be
increase
 Loan levy can be introduced or increased
 The state can cut back on its expenditure by postponing or
cancelling government projects
 Financing of the budget deficit must be undertaken on non
inflationary basis by loans from non-banking sector (SELLING
BONDS)
 A surcharge on imported goods to control inflation
 Another method is stimulating supply side economy
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Reduce taxation for people to work harder
Reduce company tax to encourage investment and capital
formation, etc
Reducing government spending
Inflation – Combating measures
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Monetary Measures
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A fine balance must be maintained between goods and services
and the monetary sector. Therefore it is the responsibility of the
monetary authorities to adjust the quantity of money to the
needs of the economy
Inflation caused by excess demand can be curbed if the monetary
authorities reduce the money supply
The monetary authorities can raise the bank rate (repo rate). An
increase encourages savings
Excessive inflation causes inflation. To reduce this restrict the
granting of credit by banks
Monetary authorities can apply moral pressure on financial
institutions – more careful when granting credit
Relaxing exchange controls is used as a measure to combat
inflation
Inflation – Combating measures
 Other (non monetary) measures
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Increasing productivity to reduce inflation
Price control as a direct method to combat inflation
A wage policy to break the inflationary spiral
Stricter condition for consumer credit can restrict excessive
demand
Encouraging personal savings as a means to combat
inflation
Import control to be relaxed to allow more goods to enter
the country to avoid an increase in prices
A floating exchange rate that will automatically adjust
depending on international trade/conditions
Inflation targeting as a policy measure to curb inflation