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inflation

Page history last edited by Brian D Butler 9 years, 8 months ago

 

Inflation

 

simple definition of inflation:

 

more advanced definition of inflation :

  • money is worth less (value in terms of real products) in the future.

 

 

Complicating the definition of inflation:

  • "the typical framework economists use to think about inflation - which they proxy by changes in the CPI - is narrow, incomplete and fails to do justice to the richness of inflation as a concept. Asset markets (e.g. real estate, equities, etc.) are as prone to inflationist policy as product markets (indeed, in recent decades they have been far more prone to inflation than product markets), so one way of buying inflation - at least in its early stages - is to buy risk assets."[1]
  • BACK in 2002 Ben Bernanke, then still a Federal Reserve governor, declared that “under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” That does not mean it is easy. [2]
  • Milton Friedman’s dictum that “inflation is always and everywhere a monetary phenomenon.” But the role of the money supply in creating inflation is less obvious than monetarism suggests.  The quantity theory of money holds that the money supply, multiplied by the rate at which it circulates (called velocity), equals nominal income. Nominal income in turn is the product of real output and prices. But does money supply directly boost nominal income, or does nominal income affect velocity and the demand for money? The mechanism is murky.   [3]

 

 

Predicting / measuring expected future inflation:

 

one measure of expected inflation – the gap between yields on conventional and index-linked Treasuries – has collapsed to 14 basis points

 

 

Data from the Economist

 

see book:

From the Economist: "One Hundred Years of Economic Statistics: A New Edition of Economic Statistics 1900-1987

 

 

 

 

How to measure deflation / inflation?

 

The Fed’s preferred benchmark, the personal consumption expenditures price index, excluding food and energy, may rise just 0.78 percent this year, according to Macroeconomic Advisers LLC in St. Louis. That is about 1 point below the preference range that policy makers signaled in their third-year forecasts in January 2008.

 

see more in our page on inflation targeting and deflation

 

 

 

 

What causes inflation?

 

"notion, advanced by Milton Friedman more than thirty years ago, that inflation is everywhere and always a monetary phenomenon is no longer a controversial proposition in the profession"  Alan Greenspan

 

A popular way to view inflation is that "goods and services are getting more expensive".  This is fine, but its not how economists normally describe the situation, and it doesnt help you to properly understand the connection between monetary policy (interest rates from the Fed) and inflation.

 

There are two ways to view inflation:

  1. goods and services are getting more expensive
  2. the value of money (in relation to good & services) is getting worse

 

Only #2 is correct.

 

Why?  Think about wealth.  If you want to be richer, you could just print more money, right?  Wrong.  If you print more money, that doesnt mean that your country is richer and can buy more goods and services.  It means that you have more paper money.   The value of any individual unit of that paper money should be less (ie. it will take more paper money to buy the same amount of goods and services). 

 

Loose monetary policy (low interest rates leading to more money being borrowed and spent) is the main underlying cause of inflation.

 

But, what about "price shocks" such as increased food and fuel prices?  Dont these factors lead to inflation?  Yes, but not in the same way.   Price shocks lead to a one-time readjustment of prices from one level to another, but do not lead to a spiral of increasing prices (as loose monetary policy does). 

 

The bigger threat to global inflationary pressures is more related to loose monetary policy; especially in many emerging markets where interest rates are being held way too low (often way below inflation rates leading to a dis-incentive to save).

 

 

 

 

Currency and inflation

see our page on currency

 

Importing inflation:  "currency via the debt servicing load and result in it falling RELATIVE TO THOSE with the savings and hence an increase in imported inflation" source: MacroMan blog

 

 

Where to Invest

 

in 2009:

 

In a report from the World Bank found here...

 

Exerpt:  "With stock markets and real estate prices falling down in both OECD countries and large emerging markets, it is time to look for more lucrative investments.   If you have a high-risk/high-return taste, look no further: Cuba and Zimbabwe fit the bill. Prices in both markets are low, thanks to the poor economic institutions in both countries. Yet both countries boast decent infrastructure, well-educated population (by regional standards), and, in the case of Zimbabwe, functioning judiciary. Both leaders are old: Robert Mugabe is 84; Raul Castro is 77. New leaders may be more interested in welcoming foreign investment.  The two countries came up on top of the list in a recent survey. If you have less taste for high risk, other selections include Azerbaijan, Colombia, Costa Rica, Ghana, Mozambique, and Vietnam. These economies already have taken significant steps to improve their investor attractiveness. Prices are rising, but many opportunities remain.

 

more advice from GloboTrends:  Investing strategies for 2009

 

Definition of inflation:

 

Inflation is measured as the growth of the money supply in an economy, without a commensurate increase in the supply of goods and services. This results in a rise in the general price level, as measured against a standard level of purchasing power. There are a variety of measures of inflation in use, related to different price indices, because different prices affect different people. Two widely known indices for which inflation rates are commonly reported are the Consumer Price Index (CPI), which measures nominal consumer prices, and the GDP deflator, which measures the nominal prices of the goods and services produced by a given country or region.

 

Inflation occurs when the general level of prices is rising.

 

Today, we calculate inflation by using price indexes – weighted averages of the prices of thousands of individual products.

 

The consumer price index (CPI) Measures the cost of a market basket of consumer goods and services relative to the cost of that bundle during a particular based year.

 

The GDP deflator is the price of GDP

 

The rate of inflation is the percentage change in the price level:

 

 

 

 

Three Strains of Inflation

 

Low Inflation

 

Los inflation is characterized by prices that rise slowly and predictably.

As a single – digit annual inflation rate.

When prices are relatively stable, people trust money because it retains its value form month to month and year to year.

 

Galloping Inflation

 

Inflation in the double digit or triple digit range

Galloping Inflation is relatively common, particularly in countries suffering from weak governments, war or revolution.

 

Hyperinflation

 

Deadly strain – rising a million or even a trillion percent per year. 

The major redistributive impact of inflation comes through its effect on the real value op people’s wealth.

 

Example:  Zimbabwe 2008:   In January, the government stopped counting inflation, with the last published report being 100,580% per year!   At that time, a simple loaf of bread would cost 30 billion Zimbabwean dollars.   The soda vending machines have all been turned off because it would take hours to put in the billions of coins needed to get one can of coke.   Imported from South Africa, a can of coke was selling for 15 billion Zimbabwean dollars on the black market.  Civil servants, however, are tied by a law that limits their bank withdrawls to just 25 billion per day (less than 2 cans of coke).   People are forced to go shopping with huge baskets of money, and spend it as fast as they can, before its worthless.

 

 

Anticipated vs. Unanticipated inflation

redistributes wealth from creditors to debtors, helping borrowers and hurting lenders.

An unanticipated decline in inflation has the opposite effect.

 

Inflation mostly churns income and assets, randomly redistributing wealth among the population with little significant impact on any single group.

 

Economist – A predicable and gently rising price level provides the best climate for healthy economic growth.

 

Evidence suggests that low inflation like in the USA has little impact on productivity or real input, by contrast, galloping inflation or hyperinflation can cause serious harm to productivity and to individuals through the redistribution of income and wealth.

 

Internal rate of inflation

The economy has an ongoing internal rate of inflation to which people’s expectations have adapted. This built in internal inflation rate tends to persist until shock causes it to move up or down.

 

Cost – push inflation:

The Inflation resulting from rising costs during periods of high unemployment and slack resource utilization.

 

Internal inflation

occurs when the AS and AD curves are moving steadily upward at the same rate.

 

Nonaccelerating inflation rate of unemployment (NAIRU)

Is that unemployment rate consistent with a constant inflation rate. At the NAIRU, upward and downward forces on price and wage inflation are in balance, so there is no tendency for inflation to change. The NAIRU is the lowest unemployment rate that can be sustained without upward pressure on inflation.

 

The NAIRU defines the neutral zone between excessive tightness / rising inflation and high unemployment / falling inflation.

In the short run, inflation can be reduced by raising unemployment above the NAIRU, but in the long run, the NAIRU is the lowest sustainable rate of unemployment.

 

 

• In the short run, an increase in aggregate demand which lowers the unemployment rate below the NAIRU will tend to increase the inflation rate. Recessions and high unemployment tend to lower inflation. In the short run, there is a trade off between inflation and unemployment.

 

• When inflation is higher or lower than what people expect, inflation expectation adjust. The changed inflation expectations will generally shift the short run Philips curve up or down.

 

• The long run Philips curve is vertical at the Nonaccelerating inflation rate of unemployment (NAIRU). Unemployment above (below) the NAIRU will tend to lower (increase) the rate of inflation.

 

• Philips curves are unstable across countries and time.

 

 

 

 

 

Inflation and Unemployment:  "the Phillips curve"

for many years, economists believed that inflation had an effect on unemployment, but this theory has been dis-proved.  Most economists now agree that the Philips curve, as was originaly stated, does not exist.  there is no link between inflation and unemployment (even if neat economic theory says there should be). 

 

Short-Run Phillips Curve before and after Expansionary Policy, with Long-Run Phillips Curve (NAIRU)
Short-Run Phillips Curve before and after Expansionary Policy, with Long-Run Phillips Curve (NAIRU)

 

For more discussion, visit: http://en.wikipedia.org/wiki/Philips_curve

 

 

 

 

Stagflation fears

 

definition: "stagflation" is the mixture of stagnation (low economic growth) with inflation (rising prices)

 

The coincidence of worldwide inflation scare and signs of U.S. recession and global growth slowdown have revived the 1970s stagflation specter.  Important differences exist though such as benign wage pressures, the demand-driven nature of the current slow-motion commodities boom, central bank commitment to price stability, and the prospect of further housing deflation.  NBER economists are in the midst of re-assessing the Great Inflation.  Check out: “Commodity Prices vs Recession: Difference Between Now and 1970s Stagflation” and “Retrospective on the Great Inflation: NBER Pre-Conference Papers

 

 

 

 

 

 

Links

 

see also:   rising inflation worries 2008  ,  High Oil Prices,   Weak US dollar  ,  commodities bubble in 2008  

 

Wikipedia article

 

 

 

 

 

 

 

 

 

 

 

Footnotes

  1. Dylan Grice of Societe Generale, London
  2. source: economist.com
  3. source: economist.com

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