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Inflation
Introduction
Inflation is a rise in the average price of goods over time.Inflation can have adverse effects on an economy. For example, uncertainty about future inflation may discourage investment and saving. High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future.Today, most economists favor a low steady rate of inflation.Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. Inflation rate= nominal money growth – real money demand growth Nominal money- the quantity of money measured in a particular currency; directly proportional to the price level Real money - the quantity of money measured as a constant, it is the quantity of money measured in terms of what it will buy (Real Money = Nominal money/Price Level) Higher inflation leads to similarly higher nominal interest rates When inflation rate increases by 1%, nominal interest rate is also about 1 percentage higher (FISHER HYPOTHESIS) Real interest rates do not change much Higher inflation rate is accompanied by lower unemployment rate Reduction of inflation by adjusting the level of employment
TERMS
CPI (Consumer Price Index)- the most common measure of inflation; weighted average of prices of a specified set of goods and services purchased by consumers DEFLATION - a falling in general level of prices DISINFLATION - the reduction of rate of inflation HYPERINFLATION - an out-of-control inflationary spiral STAGFLATION - high inflation combined with economic stagnation and unemployment
REASONS AND CONSEQUENCES
Reasons Lack of balance in the country’s budget Financial problems, financing the deficit of money by printing Sudden increase in production costs Significant increase in the level of energy resources Faulty structure of the economy Exported goods far exceeding imported ones Too many monopolies in the economy Imported inflation CONSEQUENCES Decrease in value of money which are not deposited in the bank Shoe-leather costs of inflation Menu costs of inflation Difficulties in comparing the prices when the level of inflation high and changes over certain time Problems with financial planning Fiscal drag