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Inflation: Is it really all bad?. Mrs. Jeane McNamara GVHS: SP 2002. What is Inflation?. Sustained increase in price level. Is inflation all bad?. Depends!--The key is that increases in real wages must be > increase in the price level. What is impacted by inflation?.

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inflation is it really all bad

Inflation: Is it really all bad?

Mrs. Jeane McNamara

GVHS: SP 2002

what is inflation
What is Inflation?
  • Sustained increase in price level
is inflation all bad
Is inflation all bad?
  • Depends!--The key is that increases in real wages must be > increase in the price level
what is impacted by inflation
What is impacted by inflation?
  • Purchasing power: given a fixed sum of $, what goods/services will it buy?
  • Real wages: what is the purchasing power of your wages
does inflation erode wages
Does inflation erode wages?
  • DEPENDS! Remember, REAL wages must be > rate of inflation
  • COLA--”Cost of Living Adjustment”--If the COLA is tied to at or above inflation, the wage earner is ok
inflation does not
Inflation does NOT...
  • SYSTEMATICALLY erode purchasing power (price changes could be tied to a specific sector of the economy)
  • DOES NOT lead to unfair prices
  • SHOULDN’T be blamed when the price of one good goes up relative to the price of another good
who is hurt by inflation
Who is hurt by inflation?
  • Lenders at fixed rates (lower than the rate of inflation)
  • Savers at fixed rates (lower than the rate of inflation)
  • Borrowers at variable rates (adjustable rates are tied to inflationary indecies)
  • Income earners at fixed wages (e.g. contract/union workers)
who is hurt by inflation con t
Who is hurt by inflation?(con’t)
  • Those individuals living on fixed incomes (NOTE: SS does allow for a COLA, but it isn’t always tied to the rate of inflation)
  • Consumers, unless wages keep pace
who is helped by inflation
Who is helped by inflation?
  • Borrowers at fixed rates (lower than the rate of inflation)
  • Lenders at adjustable rates
conclusions about inflation
Conclusions about inflation
  • Inflation tends to arbitrarily redistribute income
interest rates and inflation
Interest rates and inflation
  • The Real Rate of Interest = i-rate adjusted for inflation = TRUE borrowing power
  • The Nominal Rate of Interest = ‘expected’ interest rate + inflation = % i-rate borrower pays lender not adjusted for inflation
interest rates and taxes
Interest rates and taxes
  • Our tax system was designed for an inflation-free economy--taxes tax nominal interest rates
  • Conclusion: in periods of high inflation, taxes penalize interest income because our tax system doesn’t distinguish between real and nominal interest rates
interest rates and taxes con t
Interest rates and taxes (con’t)
  • THEREFORE: Savings and Investment are DISCOURAGED by our own tax system
types of inflation
Types of Inflation
  • Creeping--Upward pressure on the price level at a steady pace
  • Bracket Creep--inflation pushing wage earners into higher tax brackets
  • Galloping--spikey increases (ex: post WWI Germany, Latin countries)
types of inflation con t
Types of Inflation (con’t)
  • Dis-inflation: a sustained period of little or no inflation
  • Deflation: sustained decreases in the price level
how is the inflation rate measured
How is the inflation rate measured?
  • Representatives from the Commerce Department purchase the “market basket” of goods and services to come up with a “Consumer Price Index” (CPI)
  • Economists like the “core inflation” measure--the CPI with food and energy extracted
problems with the cpi
Problems with the CPI
  • Often overstated as the market basket doesn’t change in step with consumer preference and/or regional demand
what s the difference between cost push and demand pull inflation
What’s the difference between “cost-push” and “demand-pull” inflation?
  • Demand-pull inflation is driven by increased demand in the economy for goods and services
  • Cost-push inflation is driven by increased costs of production