InflationDefined as: – A SUSTAINED RISE IN THE AVERAGE LEVEL OF PRICES
Types of Inflation• DEMAND PULL• WAGE PUSH• PROFIT PUSH.
Types of InflationA. DEMAND PULLDefined as: - Excess demand pulls up prices• Often caused by increases in government spending, such as wars
Types of InflationB. WAGE PUSHDefined as: - attempts to increase wages faster than productivity• Often blamed on unions
Types of InflationC. PROFIT PUSHDefined as: - attempts to increase profits by raising prices• Often blamed on large corporations
Problems with Inflation• There are two problems generated by inflation.C. UNEVENESSE. UNCERTAINTY
Problems with InflationA. UNEVENESS – Inflation produces uneven increases in the prices of products. – In periods of inflation it is possible of have some products decrease in price, others increase slowly, while others increase quickly.
Problems with InflationA. UNEVENESS – This means that some consumers are hurt worse than others. – Buyers of gasoline are hit worse than buyers of DVD’s and computers
Problems with InflationA. UNEVENESS – People with fixed incomes will see their income fall at the same rate as inflation rises. – Some savers will see their savings fall almost as fast as the rate that inflation
Problems with InflationA. UNCERTAINTYWho else is hurt by the uncertainty and unevenness of inflation?Lenders – banks, etc.
Problems with InflationB. UNCERTAINTY – Lenders lend money to earn a profit. – To earn a profit, the interest they charge must cover all costs, and be higher than the rate of inflation.
Problems with InflationB. UNCERTAINTY – When lenders lend money, they have an expected rate of inflation at the time of the loan. – This expected rate of inflation is based on current rate of inflation, plus a guess about the future.
Problems with InflationB. UNCERTAINTY – If lenders guess right about inflation, they earn a profit. – If lenders guess wrong, they lose money.
Problems with InflationA. UNCERTAINTYNominal interest rate = the observed interest rateReal interest rate = nominal interest rate – rate of inflation
Problems with InflationA. UNCERTAINTYLenders try to set the nominal interest rate to: 1) cover costs 2) match expected rate of inflation 3) yield a profit
Inflation: Any Winners?Not everyone loses with low and moderate rates of inflation. - People whose income is flexible. - Borrowers (debtors).
Inflation: Any Winners?Borrowers win because the real value of their loan repayments decreases at the same rate as inflation rises.If their incomes rise as well, they are double winners.
Problems with InflationMuch of the United States Federalgovernment’s monetary policy, and thefocus of most introductory econtextbooks, is on the evils of inflation.In the dispute between lenders andborrowers, which side are they on?