Starter

How could inflation affect you both short term and long term?

Causes and Consequences of Inflation

CHAPTER 13.3

Inflation Inflation--defined two ways

sustained rise in the level of prices generally

sustained fall in the purchasing power of money

Since 1960s, inflation has had significant impact on U.S. economy:

limited stock market growth, increased agricultural bankruptcies

For individuals and economy as a whole reduced purchasing power of the dollar

raised interest rates

Consumer Price Index

Consumer price index (CPI) measures changes in prices of products

U.S. government surveys people to learn what they buy regularly

creates a "market basket" of about 400 typical products

each month researches current prices of these items

compares prices to reference base, years 1982 to 1984

Producer Price Index

Producer price index (PPI) measures changes in wholesale prices

reflects prices producers get for goods; tied to a reference base

Over 10,000 PPIs for individual products and groups of products

Inflation rate--rate of change in prices over a set period of time

PPI tends to lead CPI as indicator of inflation

Types of Inflation Moderate rate of inflation--between 1 and 3

percent per year

Creeping inflation--moderate inflation over a period of time

Galloping inflation--rapid increase

Hyperinflation--over 50 percent per month

Deflation--decrease in general price level; happens rarely

What causes inflation?

Demand-pull inflation--total demand rises faster than production

If total demand rises faster than production, it creates scarcity

during lag period, demand pushes up prices for available products

Too much money printed during lag period will drive prices up

Cost-push inflation--increases in production costs push up prices

When production costs increase, producers make less profit

if demand is strong, may raise prices to maintain profits

Cost-push inflation may be due to higher price of materials, energy

Wages can be large part of production costs; wage-price spiral:

higher wages lead to higher costs, which lead to higher prices, which lead to higher wages

Effects of Inflation EFFECT 1: Decreasing Value of the Dollar

Rising consumer price index represents declining value of the dollar

People on a fixed income are especially vulnerable

each dollar they have buys less every year

Inflation helps people who borrow at a fixed rate of interest

pay debts with dollars that are worth less, so repayments are smaller

Effects of Inflation EFFECT 2: Increasing Interest Rates

Lenders raise interest rates to ensure profit on loans

Businesses avoid borrowing to expand or make capital improvements

Consumers less likely to finance high-priced items

Monthly credit card payments go up as rates rise

Effects of Inflation EFFECT 3: Decreasing Real Returns on

Savings

Interest on savings tends to increase during inflationary times - but rate of inflation tends to outpace interest rates

Inflation worries people about drop in standard of living, retirement