Inflation questions

Inflation has reached its highest rate for two-and-a-half years, mainly as a result of the rising price of fuel.

Annual inflation as measured by the Consumer Prices Index (CPI) reached 1.8% last month, the Office for National Statistics (ONS) said, up from a rate of 1.6% in December.

It is the fourth consecutive month that the rate has risen and takes inflation to its highest since June 2014.

Fuel prices hit a two-year high in early February, according to the RAC.

As well as fuel, the ONS said food prices also contributed to the rise in inflation, as prices were unchanged between December and January, having fallen a year ago.

Offsetting these factors, the prices of clothing and footwear fell by more than they did 12 months ago

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Questions

1. If inflation is 5% does this mean all prices are rising?

2. Why might import prices rise?

3. Who are the winners and losers when there is inflation?

4. How does inflation affect the exchange rate?

5. If prices rise, won't that lead to people buying less and then the price will fall?

6. Why might the price of clothing and footwear have fallen?

Inflation and firms

Inflation has hit an all-time low in the UK. This is good news for wages and house prices, but what does it really mean for small businesses?

Inflation was down to 1.6 per cent in March, its lowest since 2009. But it is still important that small businesses remain mindful of its effects. Even a small increase could hurt capital expenditure and increase the cost of production for goods businesses.

Controlled inflation is seen as healthy stimulus for the economy as a whole, but it can be a challenging beast to keep in check. The Government’s target inflation rate is set at 2pc, and anything over this figure can reduce the value of money, both for individuals and businesses.

Larger corporations are generally better positioned to bear the brunt of inflation, as it can be offset by savings generated by economies of scale. Small firms, however, often take a direct hit on margin.

High inflation can also have unexpected side effects: it can negatively affect currency exchange rates and bring about an export slump: rising prices in the UK make goods and services uncompetitive on a global scale.

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Impact of inflation on firms

Firms generally prefer inflation to be low and stable. If inflation rise above 3 or 4%, firms may see a rise in costs and uncertainty. In some circumstances, high inflation can negatively affect a firms profits. However, it is worth pointing out that deflation (falling prices) could also be very damaging for economic growth and firms.

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Causes Cost Push Inflation

Cost-push inflation

Cost-push inflation occurs when firms respond to rising costs by increasing prices in order to protect their profit margins.

There are many reasons why costs might rise:

1. Component costs: e.g. an increase in the prices of raw materials and other components. This might be because of a rise in commodity prices such as oil, copper and agricultural products used in food processing. A recent example has been a surge in the world price of wheat.
2. Rising labour costs - caused by wage increases, which are greater than improvements in productivity. Wage costs often rise when unemployment is low because skilled workers become scarce and this can drive pay levels higher. Wages might increase when people expect higher inflation so they ask for more pay in order to protect their real incomes. Trade unions may use their bargaining power to bid for and achieve increasing wages, this could be a cause of cost-push inflation
3. Expectations of inflation are important in shaping what actually happens to inflation. When people see prices are rising for everyday items they get concerned about the effects of inflation on their real standard of living. One of the dangers of a pick-up in inflation is what the Bank of England calls “second-round effects" i.e. an initial rise in prices triggers a burst of higher pay claims as workers look to protect their way of life. This is also known as a “wage-price effect"
4. Higher indirect taxes – for example a rise in the duty on alcohol, fuels and cigarettes, or a rise in Value Added Tax. Depending on the price elasticity of demand and supply for their products, suppliers may choose to pass on the burden of the tax onto consumers.
5. A fall in the exchange rate – this can cause cost push inflation because it leads to an increase in the prices of imported products such as essential raw materials, components and finished products
6. Monopoly employers/profit-push inflation – where dominants firms in a market use their market power (at whatever level of demand) to increase prices well above costs

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Causes of demand pull inflation

What are the main causes of Demand-Pull Inflation?

1. A depreciation of the exchange rate increases the price of imports and reduces the foreign price of a country's exports. If consumers buy fewer imports, while exports grow, AD in will rise – and there may be a multiplier effect on the level of demand and output
2. Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher government spending. If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand in the circular flow
3. Monetary stimulus to the economy: A fall in interest rates may stimulate too much demand – for example in raising demand for loans or in leading to house price inflation. Monetarist economists believe that inflation is caused by “too much money chasing too few goods" and that governments can lose control of inflation if they allow the financial system to expand the money supply too quickly.
4. Fast growth in other countries – providing a boost to UK exports overseas. Export sales provide an extra flow of income and spending into the UK circular flow – so what is happening to the economic cycles of other countries definitely affects the UK

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Causes of Inflation

What are the main causes of inflation?

Inflation is a sustained rise in the general price level. Inflation can come from both the demand and the supply-side of an economy

• Inflation can arise from internal and external events
• Some inflationary pressures direct from the domestic economy, for example the decisions of utility businesses providing electricity or gas or water on their tariffs for the year ahead, or the pricing strategies of the food retailers based on the strength of demand and competitive pressure in their markets.
• A rise in the rate of VAT would also be a cause of increased domestic inflation in the short term because it increases a firm's production costs.
• Inflation can also come from external sources, for example a sustained rise in the price of crude oil or other imported commodities, foodstuffs and beverages.
• Fluctuations in the exchange rate can also affect inflation – for example a fall in the value of the pound against other currencies might cause higher import prices for items such as foodstuffs from Western Europe or technology supplies from the United States – which feeds through directly or indirectly into the consumer price index

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Consequences of Inflation

Consequences of Inflation

Many governments have set their central banks a target for a low but positive rate of inflation. They believe that persistently high inflation can have damaging economic and social consequences.

1. Income redistribution: One risk of higher inflation is that it has a regressive effect on lower-income families and older people in society. This happen when prices for food and domestic utilities such as water and heating rises at a rapid rate
2. Falling real incomes: With millions of people facing a cut in their wages or at best a pay freeze, rising inflation leads to a fall in real incomes.
3. Negative real interest rates: If interest rates on savings accounts are lower than the rate of inflation, then people who rely on interest from their savings will be poorer. Real interest rates for millions of savers in the UK and many other countries have been negative for at least four years
4. Cost of borrowing: High inflation may also lead to higher borrowing costs for businesses and people needing loans and mortgages as financial markets protect themselves against rising prices and increase the cost of borrowing on short and longer-term debt. There is also pressure on the government to increase the value of the state pension and unemployment benefits and other welfare payments as the cost of living climbs higher.
5. Risks of wage inflation: High inflation can lead to an increase in pay claims as people look to protect their real incomes. This can lead to a rise in unit labour costs and lower profits for businesses
6. Business competitiveness:If one country has a much higher rate of inflation than others for a considerable period of time, this will make its exports less price competitive in world markets. Eventually this may show through in reduced export orders, lower profits and fewer jobs, and also in a worsening of a country’s trade balance. A fall in exports can trigger negative multiplier and accelerator effects on national income and employment.
7. Business uncertainty: High and volatile inflation is not good for business confidence partly because they cannot be sure of what their costs and prices are likely to be. This uncertainty might lead to a lower level of capital investment spending.

Overall, a high and volatile rate of inflation is widely considered to be damaging for an economy that trades in international markets. In your analysis focus on the impact on

• Uncertainty / business and consumer confidence
• The competitiveness of producers in international markets
• The effects on the real standard of living
• The possible impact on levels of income inequality

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Inflation - revision

Business and Inflation from tutor2u

Inflation, Deflation, Disinflation

The Difference Between Inflation, Deflation, and Disinflation

Inflation is a general increase in the price level. The price level represents the prices of most products in an economy. Thus, the prices of most products are increasing during periods of inflation. The forces of supply and demand still determine prices in individual markets. Yet, inflation creates a tendency for prices to rise throughout the economy.

The inflation rate measures how quickly the price level changes. It is usually reported on an annual basis. In October 2003, for example, the inflation rate was 2.04%. This means that if prices rose at this same rate for an entire year, then they would be 2.04% higher on October 1, 2004 than they were on October 1, 2003. (The price index was actually 0.17% higher on October 31, 2003 than it was on October 1, 2003. Twelve months multiplied by 0.17% yields an annual rate of 2.04% per year.)

Deflation is a general decrease in the price level. During periods of deflation, the prices of most products are decreasing. Deflation is undesirable because it usually causes a significant decrease in overall spending (i.e., aggregate demand) in an economy and is most likely to occur when the economy is already stagnant. For example, deflation occurred in the United States during the Great Depression. Deflation occurs when the inflation rate is negative.

Disinflation occurs when the inflation rate decreases, but remains positive. For example, if the inflation rate changes from 6% in January to 5.5% in February to 5.2% in March, economists would say there is disinflation in the economy during the first quarter of the year (i.e., during January, February and March)

Source.......Source

Inflation, Deflation

AS Macro Revision: Inflation and Deflation from tutor2u

Inflation, Disinflation, Deflation

Inflation, Deflation, Disinflation –  What’s the Difference?

Increasingly in the media, there are discussions relating to deflation: are we experiencing deflation, and is deflation worse than inflation? Occasionally, discussions of the economy refer to disinflation. This will be the first in a series of posts exploring price changes and their implications for investing.

Inflation: our old familiar friend
Inflation is a pretty familiar phenomenon for most people; we’re used to seeing prices go up generally over time. If you’re old enough, you may even remember the 1970’s, when prices spiraled dramatically upward and President Gerald Ford encouraged everyone to respond by wearing “Whip Inflation Now” lapel buttons.  To no one’s surprise, this wasn’t enough to end inflation.

Disinflation: kinder, gentler inflation
Disinflation is a convenient way of saying that the inflation rate is decelerating: prices are still going up over time, but they’re not increasing as fast as they were in some previous time period.  At the end of the 1970’s we experienced disinflation as the annual inflation rate declined from a nasty peak around 15%.  In the latter half of last year, the CPI inflation measures began signaling a decline in inflation, so we’ve experienced a less extreme period of disinflation more recently.

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Inflation, deflation - causes and effects

Definition: Inflation is when prices rise, and deflation is when prices fall. You can have both inflation and deflation at the same time in various asset classes. When taken to extreme, both are bad for economic growth, but for different reasons. That's why the Federal Reserve, the nation's central bank, tries to control them. Here's how to recognize the signs of rampant inflation and deflation, and to protect your finances.

How to Tell the Difference Between Inflation and Deflation

There are fives types of inflation. The worst is hyperinflation. That's when prices rise more than 50% a month. Fortunately, it's rare. That's because it's only caused by massive military spending. On the other end of the scale is asset inflation, which occurs somewhere nearly all the time. For example, each spring oil and gas prices spike because commodities traders bid up oil prices. They anticipate rising demand at the pump thanks to the summer vacation driving season. 

The third type, creeping inflation, is when prices rise 3% a year or less. It's somewhat common. It occurs when the economy is doing well. The last time it happened was in 2007.

The fourth type is walking, or pernicious, inflation. Prices increase 3-10% a year, enough for people to stock up now to avoid higher prices later. Suppliers and wages can't keep up, which leads to shortages or prices so high most people can't afford the basics.

The fifth type, galloping inflation, is when prices rise 10% or more a year. It can destabilize the economy, drive out foreign investors, and topple government leaders. It's a result of exchange rate fluctuations.

Deflation is when prices fall, but it can be difficult to spot. That's because all prices don't fall uniformly, and you can even have inflation in some areas of the economy.

For example, there was deflation in oil and gas prices in 2014, while prices of housing continued to rise, although slowly. However, the Federal Reserve measures the core inflation rate, which takes out the volatile price changes of oil and food.

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Inflation and deflation

Inflation and deflation

Inflation and deflation arise from changes in either the demand side or supply side of the macro-economy.

Demand pull inflation

Demand pull inflation usually occurs when there is an increase in aggregate monetary demand caused by an increase in one or more of the components of aggregate demand (AD), but where aggregate supply (AS) is slow to adjust.

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We should still fear deflation

TThe level of inflation poses a risk to the UK economy, but not in the way that you might think. Inflation is worryingly low, rather than worryingly high.

That may seem a perverse idea at a time when the cost of living as measured by the consumer prices index has risen to its highest level in a year. But consider the following.

The annual inflation rate did not rise in January because retailers were jacking up their prices. On the contrary, a representative sample of goods and services measured each month by the Office for National Statistics was 0.8% cheaper in January than it was in December.

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Different types of Inflation

What is Deflation ? :

Deflation is the opposite of inflation.   Deflation refers to  situation, where there is decline in general price levels.   Thus, deflation occurs when the inflation rate falls below 0% (or it is negative inflation rate).   Deflation increases the real value of money and allows one to buy more goods with the same amount of money over time.   Deflation can occur owing to reduction in the supply of money or credit.   Deflation can also occur due to  direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy.

What is Stagflation :

Stagflation refers to economic condition where economic growth is very slow or stagnant and prices are rising.  The term stagflation was coined by British politician Iain Macleod, who used the phrase in his speech to parliament in 1965, when he said: “We now have the worst of both worlds - not just inflation on the one side or stagnation on the other. We have a sort of ‘stagflation’ situation.”    The side effects of stagflation are increase in  unemployment- accompanied by a rise in prices, or inflation. Stagflation occurs when the economy isn't growing but prices are going up. At international level, this happened during mid 1970s, when world oil prices rose dramatically, fuelling sharp inflation in developed countries.
 

What is Hyperinflation :

Hyperinflation is a situation where the price increases are too sharp.  Hyperinflation often occurs when there is a large increase in the money supply, which is  not supported by growth  in Gross Domestic Product (GDP).  Such a situation results  in an imbalance in the supply and demand for the money.  In this this remains  unchecked;  it results into sharp increase in prices and depreciation of the domestic  currency.

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Inflation or Deflation - which is the greatest risk?

Most people understand that a drastic increase in a country's money supply will produce inflation. 

This is because if the monetary supply increases faster than demand, the value of each unit of currency will fall. 

To put it another way, if the supply of money were to grow faster than the demand for it, the result would be too many dollars chasing too few goods which is the very definition of inflation. Despite the Fed's massive capital infusion, why is inflation only 1.4%? 

This is the precise question we will attempt to answer in this article

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Limitations of CPI

Limitations of the Consumer Price Index as a measure of inflation

Few households are average – the published figure for inflation is rarely the actual rate of inflation experienced by different people

1. The CPI is not fully representative - it will be inaccurate for the ‘non-typical’ household, e.g. 14% of the CPI index is devoted to motoring costs - inapplicable for non-car owners.
2. Spending patterns: e.g. Single people have different spending patterns from households that have one or more children
3. Changing quality of goods and services: Although the price of a good or service may rise, this may also be accompanied by improvements in quality / performance of the product
4. New products: The CPI is slow to respond to new products and services – the CPI basket is changed each year but only a few items fall out / come in

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Falling prices....

Falling inflation does not mean falling prices!

• Please remember that a fall in the rate of inflation is not the same thing as a fall in prices!
• In 2009 there was a drop in inflation from 5 per cent to 1 per cent over the course of the year. Inflation was falling – but the rate remained positive – meaning that prices were rising but at a slower rate!
• A slowdown in inflation is not the same as deflation!
• For this to happen, the annual rate of price inflation would have to be negative.

How is the rate of inflation calculated?

• The cost of living is a measure of changes in the average cost of buying a basket of different goods and services for a typical household
• In the UK the main measure of inflation is the consumer price index (CPI)

Calculating a weighted price index

• CPI is a weighted price index. Changes in weights reflect shifts in the spending patterns of households in the British economy as measured by the Family Expenditure Survey.

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Measuring inflation

What is inflation?

Inflation is a sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money

How is the rate of inflation measured?

• The rate of inflation is measured by the annual percentage change in consumer prices.
• The British government has set an inflation target of 2% using the consumer price index (CPI)
• It is the job of the Bank of England to set interest rates so that aggregate demand is controlled, inflationary pressures are subdued and the inflation target is reached
• The Bank is independent of the government with control of interest rates and it is free from political intervention. The Bank is also concerned to avoid price deflation

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