Inflation and Anti-inflation policy

Content

Inflation and its measuring Types of inflation Causes of inflation Cost of inflation Inflation and unemployment. The

Phillips curve Anti-inflationary policy

Inflation rate in different countries: USA – 2% (2012) UE - 2,6% China -3,1% India -6% Belarusia-59,1% Moldova -4,5%

Dynamics of the Inflation Rate in the R. Moldova

(1993 - 2008)

Year π (%) Year π (%)1993 2705,7 2004 12,5

1994 104,6 2005 10,5

1995 23,8 2006 14

1997 11,2 2007 13,1

1998 18,3 2008 7,3

1999 43,3 2009 12,5

2000 18,4 2010 8,1

2002 4,4 2011 7,8

2003 15,7 2012 4,5

November, 29, 1993 – the introduction of Moldovan Leu2013 – 4,9%

Inflation is a major type of macroeconomic disequilibrium.

 Over the last 400 years there have been many periods of inflation

Inflation has been defined as “too much money chasing too few goods”

The word “inflation” from roman means “swelling”

Inflation is the opposite of deflation.

Deflation occurs when the general level of prices is falling.

Disinflation means the reduction in the rate of inflation but not enough to cause deflation.

The rate of inflation is the rate of change of the general price level and is measured as follows:  

Price level = price index Consumer price index

Producer price index

GDP Deflator

TYPES OF PRICE INDEXES

1. The Laspeyres Index measures the change in the cost of the market basket purchased by the consumer in the original year:

2. The Paache Index measures the change in the cost of the market basket purchased in the current year:

3. The Fisher Index

Types of the inflation According to the character of inflation are

distinguished : open and depressed inflation  Depending on growth rate of inflation three types

are defined: Moderate (Ir < 10%) Galloping (10%< Ir <100%) Hyperinflation (40-50% a month or more than

1000% one year) Example: November, 1923, Germany 1$ = 4,2 trillion German marks 1945–1946, Hungary, Price index = 3,8 x 1027  

Types of inflation According to the mechanism of action:

Demand-pull inflation Cost-push inflation Built – in inflation, induced by adaptive

expectations, often linked to the “price - wage spiral” 

According to the consequences two major types of inflation are distinguished: Anticipated Unanticipated  

Demand-pull inflation Demand-pull inflation caused by increase in the AD. Mechanism of the demand-pull inflation is following:

M↑ AD↑ P↑ Reasons: high military spending Budget deficit, National Debt credit expansion of Banks additional issue of money, high velocity of money

circulation (V) changes in the behavior of economic agents

Demand-pull inflation caused by increase in the AD.

Mechanism of the demand-pull inflation is following: M↑ AD↑ P↑

a) Short-run b) Long-run

P P2 P1

LRAS

AD2

AD1

E2

E1

Y* Y

P P2 P1

SRAS

AD2

AD1

E2

E1

Y1 Y2 Y

Cost-push inflation Cost-push inflation caused by an

increase in the cost of production and a decrease in the ASP↑ Cost of Production↑ AS↓

Reasons: Lower productivity an increase in the prices of imported

raw materials an increase in wages of officials dominated monopolism trade-union regulation of Labor market high indirect taxes

Cost-push inflation caused by an increase in the cost of production and a decrease in the ASMechanism of the cost-push inflation: P↑ Cost of Production↑ AS↓

P     P2  P1

LRAS SRAS2

SRAS1

AD

E2

E1

Y2 Y* Y

Built – in inflation (“price – wage spiral”) Mechanism of the inflation spiral “price –

wage” M↑AD↑P↑W↑Cost↑SRAS↓P↑W↑AD↑P↑W↑C

ost↑SRAS↓P↑W↑ … and so on   Inflation spiral means the situation, in which

inflation is caused by demand and supply factors. Action of one factor is determined by the action of previous counterpart factor.

 

Built – in inflation (“price – wage spiral”)

PP5

P4

P3

P2

P1

SRAS2

SRAS1

AD3

AD2

SRAS3

E5

E4

E3 E2

E1

Y

AD1

Mechanism of the inflation spiral “price – wage”M↑ AD↑ P↑ W↑ Cost↑ SRAS↓ P↑ W↑ AD↑ P↑ W↑ Cost↑ SRAS↓ P↑ W↑ … and so onInflation spiral means the situation, in which inflation is caused by demand and supply factors. Action of one factor is determined by the action of previous counterpart factor.

monetary factors (additional issue of Money, budget deficit, high velocity of money circulation, negative consequences of Government credit-monetary policy and so on)

economic-productive factors (high monopolism, changes in the cost of production, results of income policy of Government)

outside factors (import of inflation) psychological factors (rational and adaptive

expectations of business and consumers)

Determinants of inflation

CAUSES OF INFLATIONThere are different schools of thought as to what causes inflation. Quantity theory of Money. M. Friedman said “Inflation is always and everywhere a monetary phenomenon”.  FISHER EQUATION:

PYMV

YMV

P

where: M – mass of money

P – general price level

V – velocity of money circulation

Y – real GDP3 reasons of raising prices:

M ↑(additional issue

of Money)

V ↑ Y ↓

major cause

Anti - inflationary Policy of Government

active policy adaptive policy

MAJOR GOALS

1. to limited negative consequences of inflation

1. to eliminate sources of inflation

2. to provide price stability

to prepare for anticipated inflation

MEASURES

Indexation of wages, pensions…

Compensation of losses

Supporting the well-being of population

Monetary :1)control over issue of M 2)control over lending ability of credit institutions (tools of tight credit-monetary policy) 3)nullification of monetary unit Non-monetary :1) Against Demand-pull inflation – Public expenditures –Tax rate– Budget deficit 2)Against Cost-push inflation: antimonopoly regulationintroduction advanced technologies (cost of Production ↓ , Production ↑ )wage and price controlsstructure policy of Government

Phillips curve (short-run)

U*

U*

A

U

Phillips curve and its transformation into stagflation curve (long-run)

(% per year)Stagflation curve

Phillips curve

U (% per year) U2 U3 U*

U*

AI

AII

A

B

C

D

1

2

3

*

The Phillips curve shows the trade off between inflation and unemployment.According to this view, a nation can buy a lower level of unemployment if it is willing to pay the price of a higher rate of inflation.

People can prepare for anticipated inflation by indexing incomes, benefits, loans. Rational economic agents can take anticipated inflation fully into account in their actions and decisions and protect themselves.  Common consequences of anticipated and unanticipated inflation are following:

Purchasing power of money ↓

PPPM 1

, P – is price level

Inflation tax ↑

1

1

t

t

PMT .inf

“flight from money”

transaction cost ↑ (shoe-leather cost, menu cost, cost of relative price distortions, cost of confusion and inconvenience)

outflow of capital

investment and saving are discouraged

SPECIFIC CONSEQUENCES OF UNANTICIPATED INFLATION:

Arbitrary redistribution of wealth:from borrowers to lenders from workers to businessfrom population with fixed income to population with flexible incomefrom pensioners to young people