Inflation

Last updated Jul 29, 2023 Edit Source

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• Inflation is a persistent and appreciable rise in the general level of prices
  • Inflation refers to the rate of change of the general price level (GPL)
• Rate of Inflation:
  • $\frac{Price\\ Index\\ in\\ Year\\ 2\\ -\\ Price\\ Index\\ in\\ Year\\ 1}{Price\\ Index\\ in\\ Year\\ 1} \times 100$
  • Measured as a percentage

• CPI - Consumer Price Index
  • CPI is a measure that examines the weighted average of prices of a basket of consumer goods and services 500
  • CPI takes price changes for each item in the predetermined basket of goods/services and averages them
    • The goods are weighted according to their importance
• RPI - Retail Price Index
• WPI - Wholesale Price Index
• PPI - Producers Price Index

• Headline inflation (headline rate) is a measure of inflation within an economy
  • Headline inflation may not be an accurate picture of an inflationary trend since sector-specific inflationary spikes are unlikely to persist
  • Headline inflation is what you see generally in the news
• Core (or underlying) inflation is calculated from a CPI minus the volatile food and energy components
  • It removes the volatile sectors which may influence headline inflation but should not be counted in the inflationary trend since the price increases may not be persistent
  • Core inflation is used by policy makers when making policies to avoid the distortions created by volatile price changes

• Demand-pull inflation occurs when aggregate demand (AD) rises at a rate that is not matched by the output of goods and services (aggregate supply - AS)
• Aggregate Demand (AD) = C + I + G + (X $-$ M)
  • Demand from households, firms, government and foreign sector

• Cost-push inflation occurs when rising cost of production are passed on to consumers who then pay higher prices for final goods and services
  • Cost reflect the prices paid for productive inputs
  • Independent of AD

• Consumer Effects:
  • Loss of confidence in currency
    • As inflation rises, purchasing power of money falls, ceteris paribus
      • People are less willing to hold money
    • People try to preserve wealth by buying assets or foreign currency
      • Buying foreign currency causes domestic currency depreciates worsening inflation
  • Redistribution of income
    • Debtors vs Creditors
      • Real value of debt falls → encourages borrowing
      • Real value of their loans fall when loans are repaid → discourages lending
        • Banks use interest rates to minimise the effect of inflation
    • Variable Income Earners vs Fixed Income Earners
      • Variable Income → Income is linked to GPL
        • As GPL increases, income increases as well
        • Real value of income remains constant
          • Better off
      • Fixed Income → Income does not increase with GPL
        • Purchasing power decreases
        • As GPL rises, real value of their income falls
          • Worse off
    • Real Savings vs Nominal Savings
      • Inflation erodes the value of savings (in cash)
        • Savers in cash are worse off
        • Purchasing power of savings fall over time
      • Those who save in terms of real assets gain, as the value of these assets tend to rise with GPL
        • Savers in assets are better off
• Producer Effects:
  • Effects on production
    • Two degrees of inflation with different effects:
      • Mild inflation:
        • Input costs rise slower than product price
          • Pros outweigh cons
        • Pros:
          • Stimulates production due to high expected returns
            • Rise in investment
            • Rise in employment and productive capacity
        • Cons: (counterpoint - less important)
          • Rise in product prices → rise in profits
            • No incentive to conduct research and development
            • Rise in complacency and fall in efficiency
      • Hyperinflation:
        • Input costs rise faster than product price
          • Cons outweigh pros
        • Cons:
          • Business operate at a loss
            • Can lead to shut down or fall in production
        • Pros: (counterpoint - less important)
          • Surviving firms are forced to be more efficient in order to remain in business
  • Effects on investment
    • High inflation rates associated with uncertainty about the future
      • Fall in investment
        • Fall in actual and potential economic growth
      • Making planning difficult
      • Adverse effects on planned capital investments
• Government Effects:
  • Effects on government finance
    • Direct taxes come from incomes and profits
      • Mild inflation → greater incomes → greater tax revenue
    • In the longer run, benefits cannot offset costs of inflation on society and the economy

• 2023 - CPI Annual Change (%) June → 6%
  • Causes of Inflation:
    • Rising prices of fuel
  • Impact on General Prices/Type of Inflation:
• 2022 - CPI Annual Change (%) June → 6.1%
  • Causes of Inflation:
  • Impact on General Prices/Type of Inflation:
• 2021 - CPI Annual Change (%) June → 3.8%
  • Causes of Inflation:
  • Impact on General Prices/Type of Inflation:
• 2020 - CPI Annual Change (%) June → -0.3%
  • Causes of Inflation:
  • Impact on General Prices/Type of Inflation:
• 2019 - CPI Annual Change (%) June → 1.6%
  • Causes of Inflation:
  • Impact on General Prices/Type of Inflation:
• 2018 - CPI Annual Change (%) June → 2.1%
  • Causes of Inflation:
  • Impact on General Prices/Type of Inflation:

• https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/latest-release