Category: Inflation

Inflation

Inflation refers to the progressive rise in the prices of goods and services. This makes living costly and results in a reduction in moneys power to purchase¹⁴. The rate of inflation is the adjustment in the index of price in a single year to a new one expressed in percentages. A reduction in the rate of inflation is not directly proportional to the items prices¹.

Consequently, it leads to high unemployment rates, lowered standards of living, reduced balance of payment, and obstructed economic growth⁸. It is currently set at 2% in Britain². To control the inflation, the causes must be known and dealt with. This paper argues that policies adopted by a government may be more detrimental than helpful to its economy.

The major factors that can trigger inflation include the availability of items for purchase against the command of the same, and vice versa. This is in addition to domestic and peripheral occurrences. Moreover, continuous variation in the rate of replacement of different currencies during trade can also influence inflation¹². These also make yearly prediction of the rate of inflation intricate.

The policies adopted by a government should help it realise high rates of employment, improved standards of living, reduced inflation, and continuous economic expansion⁹. This essay argues the need of the government to minimise cumulative demand and increase collective supply to facilitate this¹⁰.

1. Economic/monetary policy requires the government to initiate moments where the rates of interest shoot, thus, minimising prospective expenditures¹⁵. This is purposed at obtaining minimum prices of imports and attractive exports. The results would be positive because the fixed high interest rates may in turn lead to increase in the value of the rate of exchange⁶. It also involves instances where money circulation is minimised. It results in money scarcity and, thus, a decrease in aggregate demand. High rates of interest stimulate inflation⁷.
2. A policy that is concerned with making items available as the objective of this policy is to sustain reduced costs¹. It is ensured by a boost in production through diminution in levies, creating opportunities for more rival firms that would increase supply and cause a fall in prices. Furthermore, there is a decrease in company duties that in turn would encourage novelty². This causes demand for increase in remuneration. In order for employers to keep up with this, they require to reduce their workforce that leads to unemployment.
3. Financial/fiscal policy concentrates on a demand as a way to control inflation. It is done by minimising the rate of expenses on communal and value goodsand raising interests³. It is also achieved through increasing express taxes, thereby, resulting in a decline in actual disposal earnings. This would in the short term reduce demand and, thus, price cuts. However, the effects of governments withdrawal or reduction in public expenditure would affect the market and hamper development⁴. In addition, high taxation would leave consumers with less money to spend, thereby, influencing their living standards negatively. There would be an increase in unemployment since most firms would lay down workers to keep up with the tough economic trends. This policy affects investments and expansion of industries, which in turn reflects negatively on the economy. Contrary to the expectation, instead of controlling inflation, unemployment would increase. This has similar or even worse economic impacts than inflation⁵.
4. A policy concerned with the rate of exchange: improved exchange rates cause reduction in the price of imports¹³. It hinges on the aggression of the government. This in turn reduces production cost, which calls for a fall in prices and, thus, minimised profit margins. The result is improved economy since there are lower import costs and higher export charges. However, this largely depends on the countries sustained balance of payments.

It is essential to note that inflation has a way of negatively affecting other macroeconomic components such as employment and balance of payment³.

A government needs to know how to juggle the above policies in order to keep its economy healthy. This is because the first and third policies, in a bid to control inflation, would lead to other macroeconomic predicaments such as a lack of employment. It can be concluded that the weight of inflation would then greatly press on this group of people. It, therefore, calls for adoption of the right policy instruments.

Short-Run Phillips Curve before and after Expansionary Policy, with Long-Run Phillips Curve (NAIRU)⁷

List of References

1. Adam Smith Economics Tuition Agency, Inflation, 2009. Web.
2. Amos WEB Encyclonomic WEB*pedia, Inflation. Amos WEB LLC, 2000-2013. Web.
3. Baxter, M., the role of expectations in stabilizing policy, journal of monetary economics,Vol. 15, University of California, North Holland. 1985, pp 343-362
4. Broadly, D., A low and stable rate of inflation, 2013. Web.
5. Corbo, V., Reaching One digit inflation: the Chilean experience, Journal of applied economics, Vol 1, No. 1, 1998.pp 123- 163.
6. Feldstein, M. S., The welfare cost of permanent inflation and optimal short run economic policy, Journal of political economy, vol 87, no.4, University of Chicago press, 1979. Pp 749.
7. How the Phillips curve relates to aggregate supply and demand. Web.
8. Lawrence, J., ACopp& S Stoddard, AQA economics AS: Student Book: AS: Exclusively endorsed by AQA, Nelson Thornes Ltd, 2008.
9. Margetts, S., Economic policies to control inflation. Web.
10. Pettinger, T., Policies to reduce inflation, 2007. Web.
11. Policies to control inflation. Web.
12. Riley, G., AS Macroeconomics/ International economy: Government macroeconomic policy, Eton College, 2006. Web.
13. Riley, G., AS Macro revision: policies to control inflation, 2010. Web.
14. Riley, G., Inflation, 2012. Web.
15. Tutor2u, economics policies to control inflation. Web.

Introduction

The relationship between output and inflation was built by the Keynesian. He stated that the fluctuations in output arise from the changes in the nominal aggregate demand. Further, changes in the nominal aggregate demand have a real effect on the economy. The study further revealed that shocks in the economy have a real effect on the prices since an increase in the rate of inflation will make firms to change prices. Nominal shocks in the study are of significance because prices and nominal wages are partially rigid. Thus, it can be observed that shocks in the economy such as changes in aggregate demand have a real effect on the output level and the price level in the economy. This relationship leads to the creation of the Phillips curve. This analytical treatise reviews the theory behind the relationship between the output and inflation in the Philips curve.

Objectives of the paper

This paper attempts to carry out a study of the relationship between the volatility of inflation and output across various countries. Further, the paper will discuss how the results of Lucas (1973) relate with the work. The paper will also give a time series plot and scatter diagram to show the relationship between various variables for various countries (Lucas, 1973).

Literature Review

According to Benigno and Ricci (2011), rigidities within the downward nominal wages will trigger aggregate and idiosyncratic shocks for wage setters. The authors derived a Phillips curve for the long run interaction between average inflation wage and average output (Benigno and Ricci, 2011). The authors observed that the long run curve assumes a flatter shape at inflation level that is low, and assumes a vertical shape at inflation level that is high. As a variation of the market labor mobility, efficiency in allocative contributors is significant in balancing the distribution of labor units between low and high employment values as part of the wage differential matrix. Reflectively, Benigno and Ricci (2011) argue that the value of marginal product determines the regulatory effect on perfect competition and wage differential at different inflation levels.

The two components will swing until the regulator balances for employments sharing self efficiency on allocativeness as part of the wage differential (Benigno and Ricci, 2011). However, Benigno and Ricci (2011) further noted that this interaction holds in a labor market with perfect knowledge of all determinant variables operating in a similar employment industry (Benigno and Ricci, 2011). Due to similar experience, skills, and educational attainment, the wage rates are likely to balance as the regulator moderates the two determining variables in a constant mobility parameter within a definite nominal rigidity.

Benigno and Ricci (2011) explain the relationship between average wage inflation and average output by the hedonic theory of wages to classify this form of interaction between workers that have wage preference variances when interacted with ideal job amenities of nonwage nature (Benigno and Ricci, 2011). The most likely effect would be the standard labor markets inability to churn wage differentials that are sustainable for employees sharing similar capital stocks of human nature and counterparts with varying capital stocks of human nature. As a result, wage differential is skewed towards market demand within an inflation parameter. Reflectively, the variables interacting within the parameters of this interaction are inflation and output within the normal indifference curve. Consequently, the resulting interaction becomes flexible to different bundles of budget constraints that might be present at each level of computation.

Lucas (1973) offers a comprehensive analysis of the relationship between the real inflation-output tradeoff through an empirical study capturing eighteen economies within a period of two decades. Confirming the null hypothesis that the average real output levels are invariant under changes in the time pattern of the rate of inflation (Lucas, 1973, p. 326), the Lucas concluded that there is a determinate rate of output within a level of inflation. In the findings, Lucas (1973) concluded that the there is a direct relationship and variance in the tradeoff between full employment and inflation rate at a particular level of input in the countries studied.

The main assumption adopted in undertaking this empirical study is that the aggregate price-quantify observations are viewed as intersection points of an aggregate demand and an aggregate supply schedule (Lucas, 1973, p. 326). Reflectively, this empirical study revealed the relative trend of interaction between output and inflation rate that adjust in the same parameter. Basically, as indicated in the Phillips curve derived by Lucas, it is apparent that structural aspects of the economy often instigate the tradeoff scenario which is independent of the pursued demand policy. Thus, Lucas (1973) confirmed that the higher the variance of demand, the more unfavorable are the terms of the Phillips tradeoff curve (Lucas, 1973, p. 334).

From the above reflection, the literature by Lucas (1973) and Benigno and Ricci (2011) indicate a direct relationship between the aggregate output and inflation level for different interacting variables in the Phillips curve. Specifically, Benigno and Ricci (2011) identify rigidities within the downward nominal wages as triggering the aggregate and idiosyncratic shocks for wage setters in the tradeoff interaction between output level and the rate of inflation (Benigno and Ricci, 2011). On the other hand, Lucas (1973) confirms the hypothesis that higher demand variance results in higher unfavorable tradeoff variable within the Phillips curve (Lucas, 1973).

Economic theories

The Philips curve shows the negative relationship between unemployment and inflation (Ball, et al., 1988). The rate of unemployment changes as the aggregate demand and output level changes. An increase in output level results in a decrease in unemployment rate. The research analysis carried out by Lucas (1973) revealed that inflation and output moves in the same direction (Lucas, 1973). In other words, the study revealed that inflation and unemployment move in opposite direction hence the Phillips curve. His study further revealed that countries with highly variable aggregate demand curve have steep Phillip curve(Lucas, 1973). This implies that random nominal shocks in these countries have dismal effects on the output level in their economy. The relationship between unemployment and inflation is further supported by Okuns Law. It states that an increase in the unemployment rate by one point will result in a negative growth in the real GDP by two percentage points (Benigno and Ricci, 2011). Based on the labor demand and supply model, unemployment level caused by recession creates disequilibrium in the labor market, that is, there is surplus labor supply with a corresponding low demand as was seen during the 2009 global economic recession.

Data and scatter plots

Data on inflation and output will be collected for a total of eighteen countries. The data will be for a period between 1980 and 2012. The output of the eighteen countries is measured in US dollars for ease of comparison while inflation is measured using the average consumer price index.

Scatter plot diagram showing the relationship between average inflation and the variance in inflation for the countries

The table presented below gives the data for the average inflation and variance in inflation for the eighteen countries.

The scatter diagram showing the relationship between the two countries is illustrated below.

The plot shows that the changes in the inflation rate in some countries are instigated by volatility in the inflation rate. Generally, it can be observed countries that have high volatility in the rate of inflation have a low average inflation rate.

Time series plot of inflation rate over time in the US, UK, and Venezuela

The graph will show the trend of inflation rate in these countries. It gives an indication as to whether the inflation rate has been increasing over time. The time graph plot of the inflation rate for the three countries is illustrated below.

It can be observed that the rate of inflation for United Kingdom and United States increases at a steady rate. However, the inflation rate in Venezuela is quite erratic and from 2003. The value increased at a high rate. The trend of the inflation rate determines the slope of the Phillips curves as mentioned above.

Scatter plot diagram showing the relationship between inflation and output volatility using the whole sample.

The table presented below gives the data for average inflation rate and volatility in output for the eighteen countries between 1980 and 2012.

The graph drawn should give a linear relationship between average inflation and volatility in output. Countries with low volatility will fall within the line of best fit while countries with high volatility such as the United States will fall away from the line of best fit.

Comparison of the results and the related topic

Thus, it can be observed that the results of the graph are consistent with the various economic theories discussed above. There exists a positive relationship between inflation and output. Besides, unfavorable tradeoff variables in the Phillips curve are triggered by higher demand variance. The trend of the inflation rate determines the slope of the Phillips curve. Thus, it can be observed that shocks in the economy such as changes in aggregate demand have a real effect on the output level and the price level in the economy. This relationship leads to the creation of the Phillips curve.

References

Ball, L., Mankiw, G., & Romer, D. (1988). The New Keynesian Economics and the output inflation trade- off. Brookings Papers on Economic Activity, 1(1), 1  82.

Benigno, P., & Ricci, L. (2011). The inflation-output trade-off with downward wage rigidities. American Economic Review, American Economic Association, 101(4), 1436-1466.

Lucas, R. (1973). Some international evidence on the output-inflation tradeoff. American Economic Review, 63(3), 326-334.

Introduction

In a review conducted by the Federal Reserve Bank of St. Louis in 2005, it was noted that the economic hero of the inflationary decades was the then chairman of the Fed, Paul Volcker. In the review, Allan Meltzer recognizes some mistakes and policy errors. Both political and economic factors that led to the Great Inflation are identified and scrutinized. It was found out that policy errors were based on the limited independence of the Federal Reserve. Misinterpretation of the apparently flawed economic theories resulted to fruitless policy deliberations and had an impact on the increased inflation rates. It was through Volckers new policy of inflation targeting that the inflation was controlled and sustained.

The FOMC (Federal Open Market Committee) were slow in their response to the great inflation. This allowed the growth of inflation rates until it was out of control. Reasons for the 1979 monetary policy reform and how it was implemented have been analyzed in the review (Meltzer 18). The success of the reform is apparent over the past two decades characterized with higher degrees of price stability. The main principle behind the monetary policy reform was the control of the U.S money supply. Lindseys article splits the reform into five sections: how it happened, why it happened, challenges facing the FOMC, analysis of the then chairman Paul Volcker and finally the conclusion. Lindsey presented the historical description of the reform, reasons for the adoption, mechanisms of handling various challenges and tries to describe the economist Paul Volcker (Lindsey et al. 6).

Lessons for Monetary Policy

Several lessons have been learnt from the great inflation era. Personnel who have benefited from such lessons include policy makers, politicians and the public in general. The main lesson learnt from the high-inflation era is that low and stable inflation has considerable more economic benefits than high inflation. In the past two decades, substantial economic improvements have been recorded as a result of low inflation. Improvements such as a fall in economic volatility, economic growth and increased productivity have been recognized (Bernanke et al. 11). Bullard provides the following three lessons for monetary policy from the panic of 2008: lender of last resort on a grand scale, the several faces of monetary policy and the asset price bubbles. The Federal Reserve acts as the lender of last resort. Its ability to act in such a way was very innovative. It has proved to be more powerful and flexible than was previously held and has regained the confidence and support of the public. Apart from interest rate adjustment, monetary policy can also be sustained by other dimensions. Policy makers have learned better and sophisticated ways of responding to asset bubbles. Challenges were met in the recent crisis but an opportunity arose for evaluation of responses and the impacts of such responses.

The macroeconomic effects of inflation targeting

Over the past two decades, there is little or no evidence of the effects of inflation targeting on macroeconomics. A study by Bernanke et al. showed no significant short run gains in countries which had adopted inflation targeting (12). Macroeconomic elements include: balance of trade, the Gross Domestic Product (GDP) and the levels of employment. In general, there are two models of macroeconomics: the Classical model and the Keynesian model. The former is concerned with wage rates while the latter concentrates on both long term and short term interest rates.

Inflation Targeting and Optimal Monetary Policy

Features of inflation targeting include: a public announcement, a target which should strictly be adhered to and transparency. Inflation targeting has become very popular in emerging economies. Inflation targeting helps the central bank meet the objectives of monetary policy as well as promoting public understanding of the monetary policy. The theory of optimal monetary policy suggests that inflation is best at low and stable levels. A forecast of future inflation is relevant to the implementation of the optimal policy. Forecasts are done in decision cycles normally on a quarterly basis. Woodford argues for the history dependent target criterion as opposed to the common forward-looking criterion. He points out that targets based on past events handle the zero lower bound more effectively than the forward looking alternative.

He gives the example of the problem facing the Bank of Japan, which depends purely on the forward looking method. Currently, inflation targeting represents one of the greatest innovative achievements as shown by practices in banks such as the bank of Canada and the Bank of England. This has protected many central banks from the discretionary trap and improved the effectiveness of the policy (Woodford 27). As much as evidence for forward-looking is overwhelming, a backward-looking trend should not be ignored. According to Woodford, Policy makers should incorporate both backward-looking and forward-looking elements. The FOMC has explicitly indicated the level of inflation target; they intend to keep it close to zero for a long period.

Forecasting Inflation and Growth

Such forecasts have been under attacks from economics who do not agree with the policy. William Poole, the president of the Federal Reserve Bank of St. Louis is such an economist who tries to challenge the validity and reliability of the forecasts. He favors concentrating on the impacts of forecast surprises over the implementation of economic forecasts. A study conducted on the accuracy of these economic forecasts established that the accuracy declines as the forecasting horizon is extended. The inaccuracy of the forecasts (forecast error) was observed in the 2000 blue chip consensus, which missed the 2001 recession. On average, all forecasts predicted inflation rates which were higher than the actual inflation. Since 1994, the FOMC consensus has been better than the Blue Chip consensus in forecasting. In the 90s, inflation rates have been lower than what was forecasted. Forecast errors exist and pose a great financial risk. Therefore, policy makers should make informed decisions and should be ready for forecast changes (Poole 4).

Conclusion

To the majority, the Federal Reserve made the right move against the inflation problem. The policy change made in 1979 was the right choice. Some even consider the Federal Reserve as the Central Bank to the world. Though the Fed has been successful in many occurrences, they have a duty to provide for consultations and exhibit transparency. It is crucial that the Fed should never allow or encourage such inflation bursts in the future. In my view of point, I believe inflation targeting works and I support IT as a framework for the management of monetary policy in the United States. I have great confidence that IT will prevent a replay of the Great Recession.

Works Cited

Bernanke, Ben. Blinder Alan and McCallum Bennett. What Have We Learned Since October 1979? St. Louis Federal Reserve Bank Review, 2005. Print.

Lindsey, David, Athanasios Orphanides, and Robert Rasche. The Reform of October 1979: How It Happened and Why. Federal Reserve Bank of St. Louis Review, 2005. Print.

Meltzer, Allan. Origins of the Great Inflation. Federal Reserve Bank of St. Louis Review, 2005. Print.

Poole, William. Best Guesses and Surprises, Review Federal Reserve Bank of St. Louis, 2004. Print.

Woodford, Michael. Inflation Targeting and Optimal Monetary Policy, Review, Federal Reserve Bank of St. Louis, 2004. Print.

Introduction

This paper presents a detailed discussion on the effects of increase in the prices of oil both in the short run and long run period of time. The risk to growth following a progressive increase in the price of oil will be conclusively discussed both in the short run and long run period. As a response measure to the increase in the price of oil, monetary policy formulated by the Federal Reserve Bank is worth investigating and making inferences.

The threat to growth following rising price of oil

In the early 70s, decrease in the output and rising inflation rates lead to sharp rise in the price of oil. Even In the year 2007, much more rise in the price of oil was associated with fluctuation in the outputs and inflation rates.

During the same year, the alterations in the price of oil were activated by a change in the supply of the same commodity in the market place. War between the Arab and Israel prompted the formulation of an oil embargo consequently reducing the supply of oil in the market place in 1973. Another factor sourced from the supply side was the consequences of the Iranian revolution in the year 1979.

On the other hand emerging economies of china and Japan are the recent cause of the rise in the price of oil. Rapid economic growth and development taking place in these nations creates demand for oil to be used in various sectors of the economy. In recognition of the fact that developing nations are considering trading with up coming economies, expenditures on the products from the United States reduce to a greater extent.

Use of AD-AS model

This is a model relating the price with the level of production in an economy with reference to employment rates, gross domestic produce policies to stabilize inflation rates, an ultimately macroeconomic observable fact. The AS-AD model takes into custody the interface between the Aggregate Demand (buyer) and the Aggregate Supply who in this case are the sellers both analyzed in the long and short run period of time. In a macroeconomic context, aggregate demand is specified by a sum total of C+I+ G+ (X-M) in an open economy.

Effect of a rise in oil price on inflation and output

The graph below shows the effect of a rise in oil price on inflation and output. An inward shift in SRAS following a rise in the price of crude oil imparts on the price level causing a contraction of the AD signified by a movement from Y1 to Y2. Y f c represents full employment of factors of production in the long run. It is now evident that continuous increase in the price of oil reduces output level and raise inflation from P1 to P2.

Effect of the response of Reserve Bank to the oil price increase

The reserve bank can manipulate the interest rates to stimulate growth by creating demand in the economy. Low interest rates attract people to borrow from financial institution consequently raising their purchasing power. Recessions are related with the surging prices of oil and the increase in the rates of funds from the Federal Reserve Bank. It is important to focus on some economic effect of the prices of oil and the federal funds rate.

An empirical approach tries to analyze the decline in output from an increase in the price of oil. In an investigation by economic researchers, the findings were that an increase in the prices of oil and a subsequent increase in the funds rate by the Federal Reserve Bank would have a cumulative effect of lowering the gross domestic product. In the year 2004, there was a 30% increase in the price of oil from $33 to $ 45 per barrel.

The immediate reaction was maintaining the funds rates at a constant value which ultimately reduced the growth rate by only 1.2%. If the funds rates had been increased (in the form of tightening the lending rates), then prediction shows that development would have declined by 2.1%. The investigation shows a clear difference in the effect of an increase in the funds rates and when the rate is maintained at a constant value.

Federal Reserve Bank is usually responsible for the changes in the interest rates which affect the supply of money in the market. A higher interest rate acts as a disincentive to borrowing money from the bank. The succeeding consequence is little money chasing the same product. On the other hand, a decrease in the interest rates motivates people to borrow more funds from the bank therefore increasing the supply of money in the market.

This means that more money chasing the same product. Because of the competition for the same product, it is possible that growth in national income will be registered but at a higher cost of inflation as indicated in the graphical diagram above. The use of monetary instrument to influence growth in an economy by a decrease or increase in the interest rates is strictly under the control of Federal Reserve Bank.

Conclusion

This essay is explicit on the effect of high prices of oil on output and inflation rates. Exogenous variables are responsible for the shift in the AD or AS curve in the short run. The long run graphical illustration of a supply curve is a straight vertical curve.

This shows that in the long run, the supply curve is not affected by exogenous variable in the industry. To regulate the supply of money in the market, monetary policy is employed by the Federal Reserve Bank. For a progressive increase in the price of oil, the model clearly substantiates the value attached to maintaining the interest rates at a constant rate.

Reference List

Bernanke, S, M Gertler & M Watson, Oil Shocks and Aggregate Macroeconomic Behavior: The Role of Monetary Policy: A Reply, Journal of Money, Credit, and Banking, vol. 36, no. 2, 2004, 287-91.

Olekalns, N, et al, Principles of Macroeconomics, 8^th edition, McGraw-Hill, North Ryde, N.S.W, 2008.

Ever since the US economy started feeling the effects of the recent economic crisis, the Federal Reserve (Fed) has been using stimulus packages to try and rectify the money demand and supply associated with inflation. The most ambitious stimulus was the 2009 two trillion worth of bonds at the height of inflation. Most recently, the Fed is again planning to buy long-term US Treasury bonds to the tune of hundreds of billions of dollars. The rationale for this controversial decision is to stimulate public spending. The effect of this is that inflation will be slightly adjusted upwards from the current 1% to 2%. The fed officials believe that this will have long-term positive effects on the economy. When people anticipate higher future prices, it is expected that they will increase expenditure today to avoid the extra expenses of the future (Hilsenrath and Cheng 1). This relationship can be shown in a demand-supply curve as illustrated below.

The equilibrium point is a point where the value of is money adjusted thereby creating an equilibrium in the quantity of money supplied and that of the quantity of money demanded. When the Fed adjusts the quantity upwards, it results in the increment of price levels consequently pushing down the value of money. The process of regulation of the money supply as explained above is made possible by one of the Feds tools of monetary policy which is known as the Fed fund markets. This is a policy that is carried out by the central bank (Brannstrom 26).

The QE policy is aimed at regulating long-term interest rates rather than short-term interest rates. The main reason for this is that they believe if they can set a threshold of an increasing interest rate in the long run, it will encourage people to make money from their savings and use it to spend. for example, if the inflation rate is to be fixed at 2% per annum from the current 1% and one was planning to take a bank loan the following year, chances are that he would prefer to take the loan today as the loan repayment of the same loan in the next year will be higher. This will increase investment and it will therefore spur economic growth.

Hilsenrath (1) underscores the importance of pushing down inflation rates as well as the interest rates. This is a concept widely taught by economists. But the experiment conducted reveals that the fed is doing exactly the reverse of this; they are taking the risk of pushing the inflation up. While the inflation has been on a steady 1%, they argue that it is not a good enough percentage to spur growth and so they suggest pushing it up to 2%. The Fed to cause a good panic in the market that will cause people to spend more and save less. This, they believe will increase the investment thereby helping in checking on the inflation.

One notable effect of inflation is the redistributive impacts associated with inflation. As explained by Hilsenrath (1) as well as by Brannstrom (26), a high rate of inflation drives up the wage levels thereby making it easier and cheaper for the borrower to pay back his loan. For instance, if a student took a loan today to pay his fees, and the loan was due ten years later within an economy that had undergone hyperinflation, the student will have a lot of money as the wage level will have also gone higher and he will easily pay back the loan. The only problem is that the value of money will have gone down and so the bank may not make a profit out of this scenario.

Works Cited

Brannstrom, Tomas. Money Growth and Inflation. Stockholm: Economic Research Institute, 2005.

Hilsenrath, Jon and Cheng, Jonathan. fed gears up for stimulus. Wall Street Journal. 2010. Web.

Hilsenrath, Jon. Why the fed wants a tad more inflation. Wall Street Journal. 2010. Web.

The UK economy was once characetrised by high inflation, which affected the economic stability of the country (Bank of England, 2004). Inflation is defined as the change in consumer prices index (CPI) from the exact period the previous year. The CPI on the other hand is defined as a measure used by governments to measure the change in prices of specific goods and services. Some of the products and services included in CPI measurements include cost of transportation, food, electricity and housing among others.

In the 1970s, inflation was at an average of 13 percent a year and reached its peak in 1975 when it hit the 27 percent mark. In the 1980s, the prices were fairly stable and inflation was at an average of 7 percent a year. Though this is not the case anymore, the country is yet to come up with a macroeconomic policy that will ensure that prices remain stable within set inflation targets.

According to the bank, the target inflation is 2.0 percent, while the prevailing rate is at 3.0 percent. In February 2010, inflation rose to 3.5 percent and the Bank of England explained that governments action to restore value added tax to 17.5 percent influenced and led to an increase in inflation. The government had reduced VAT to 15 percent in a bid to encourage consumer spending during the 2008-2009 recession.

Causes of inflation

According to the Bank of England (2004), inflation occurs when the demand exceeds the ability by the economys capacity to produce goods and services. When this is the case, the prices rise in response to the increasing demand. With an increase in the supply of money, this automatically leads to inflation. According to Sloman (2007), excess demand in goods and services leads to demand-pull inflation.

The main causes of demand-pull inflation in the UK includes: 1) depreciation of the sterling pounds exchange rate; 2)reduction in taxation, therefore allowing consumers to have more money to spend;3)increased liquidity in the market especially when banks increase their lending to people and institutions; 4)a rise in consumer confidence especially in the real estate industry; 5) increase of asset prices ; and 6) economic growth in UK trading partner economies thus providing a ready market to the UK exports.

A different kind of inflation is the cost-push inflation (Sloman, 2007). Such is caused by external shock to the UK economy, such as fluctuations in commodity prices; depreciation of the sterling pound exchange rate; and /or the increase of unit labour costs or wages. When cost-push inflation occurs, firms usually respond by raising prices for goods and services in order to protect their bottom lines.

Effects of inflation

One of the most notable consequences of inflation is that money loses value (Sloman, 2007). As a result, people no longer have as much confidence in their currency, and usually this leads to a reduction in savings as people opt to invest in assets hoping that such will give them real value.

As one would expect, when the prices of goods and services increase, people have to find a way of maintaining their living standards. Usually, this leads to wage increase demands. Employees who cannot bargain wage increases usually end up living in poorer conditions, or working extra jobs in order to survive the inflation.

Unlike savers who are usually on the receiving end of the inflation when their savings loose value, inflation tends to favour people who borrow money since it erodes the value of their debts. This then means that inflation is less equitable and unsustainable. Economic analysts argue that a market economy such as the UK cannot survive a process where wealth is arbitrary allocated to the borrowers due to inflation effects, while the savers and people with fixed incomes loose out.

The Bank of England (2004) states that inflation increased the risks associated with borrowing and saving. This then calls for some form of insurance against the uncertainties that money may loose value. The risk premium usually results in higher interests rates, which drives the costs associated with borrowing higher and eventually, the high borrowing costs discourage investments.

According to Sloman (2007), inflation can further lead to disruption of business planning thus leading to lower investments in the long-term. It is also touted as one of the leading causes of unemployment because as employers try to keep up with the higher wage demands, they lay off some of the staff members. More to this, inflation makes it hard for business expansion thus meaning that employers cannot recruit at a high rate.

Inflation also leads to reduced global competitiveness because the basic measures of production, most specifically labour is costly. This then means that the overall price of products and service are high compared to those produced where inflation is lower. Financial institutions usually respond to inflation by instituting higher interests rates, which consequently affects the growth trend in a country.

According to the Bank of England (2004), inflation hampers long-time planning and development as business prefer to restrict spending to projects that hold the promise of high-returns in a shorter period or those that allows a quick payback. This in turn affects the economic stability of the country.

The effect of inflation on the economy is pegged on the quantity theory of money, which indicates that if the quantity of money in the hands of purchasers increase or decrease, they will be able to buy, with the same money, a lesser or a greater quantity of goods and services (Gosh, 1996).

Allen (1997) holds the opinion that the ultimate objective of the UKs economic activity is to satisfy the consumer. As such, he argues that the Consumer price Index (CPI) should be able to measure the monetary cost of achieving specific levels of utility. Notably, the UK disclaims any intention of having a specific cost in order to maintain customer satisfaction.

The cost of inflation is always high for an economy. This is regardless of whether the inflation was predicted, stable or high. While predicted inflation may be helpful because it assists economists in planning the appropriate monetary policy to use in the future, it still does not shield the economy from the overall effect brought about by the increase of prices.

This mainly is the case because businesses need to keep re-adjusting their prices. Buyers on the other hand cannot budget in advance because of the price uncertainties. Further, there are economists who argue that there is no full proof way of predicting inflation especially when the prices are volatile.

According to the Bank of England, inflation undermines the value of money as a unit of exchange and eventually leads to economic players misdirecting resources, which then leads to wasteful allocation of capital and missed opportunities for growth. According to the Banks observation, high inflation makes the messages that prices send to economic analyst vague.

Ideally, the prices of goods and services provide specific signals to the economy on the most likely profitable areas to direct resources. When inflation is high however, the signals are unclear since no one understands whether they are as a result of inflation or related to the individual product.

Monetary Policy

According to the Bank of England (2004), interest rates have always been used to control inflation rates in the UK. But how exactly does the bank do this? Well, according to its 2004 report, changing the interest rates influences the overall amount of expenditure in the country.

When the interest rate is increased, it makes saving attractive and borrowing less attractive. A reduction of interest rates on the other hand makes saving a less attractive economic venture, while appealing to the borrowers. The latter stimulates spending, while the former restricts spending. Ideally, the government observe prevailing trends in the market before either increasing or reducing the interest rates.

The use of interest rates to regulate inflation also affects the currency exchange rates. When the interest rates in the UK rise, investors who have assets in the country get increased returns for their investments. A reduction of the interest rates would also reduce import prices while making UK based assets more appealing to the international market. Unfortunately however, the Bank of England (2004) notes that interest rates do not always affect the exchange rates.

A monetary policy would stabilise the value of money by keeping inflation at low levels. This does not however mean that such a policy would permanently raise growth or output in the economy. However, the fact that the monetary policy creates a better business environment means that individual players can exploit the benefits of low inflation by concentrating on the quality and competitive production of goods and services.

A different monetary policy proposal would be for the UK to adopt a fixed exchange rate. According to Gosh (1996), there is a strong link between inflation and fixed exchange rates. This mainly stems from the discipline and confidence effects that fixed exchange rates give to an economy. However, seeing that exchange rates are affected by various economic variables, this does not look like a very suitable option.

Conclusion

Achieving low inflation rates is touted as the foundation for economic stability of the UKs economy (Bank of England, 2004). The current target inflation rate is at 2 percent, which the bank argues that it takes into account the change in quality that happens overtime in product and services. This then means that prices cannot remain constant if improvements are made on them.

Overall however, the Bank estimates that if the 2 percent is attained and maintained, the UK government will be able to set economic objectives for investments and job creations.

The 2 percent interest rate is part of the governments monetary policy intended to deliver a more certain economic environment where businesses can make long-term predictions and plans. By delivering monetary stability into the UK economy, the Bank of England will give businesses the room needed to concentrate on competitively producing goods and services for the consumer market without having to worry about inflation and the consequences that it has on their businesses.

References

Allen, W. (1997) Inflation Measurement and Inflation Targets: The UK experience. Bank of England review, 179-185.

Bank of England. (2004) Low Inflation and Business. Web.

Gosh, A. (1996) Does the exchange rate regime matter for inflation and growth? New York: IMF.

Sloman, J. (2007) Essentials of Economics. 4^th edition. New Jersey: FT Press.

Real growth and inflation are associated with the Gross Domestic Product (GDP). GDP is the total market worth of a nations products and services during a specific period (Feldstein, 2017). When Comparing periods of GDP growth, real growth takes inflation or deflation into account, while the inflationary growth rate uses actual market values to measure GDP growth. The purpose of this paper is to show the significant difference between real growth and inflationary growth.

The core difference between real and inflation growth is based on the production volume and price changes. Inflation growth focuses on the volume and prices of the goods and services produced in a given period (Ahmmed et al., 2021). When we look into real growth as a measure of economic growth, the focus is on the volume of what was produced during a specific period (Feldstein, 2017). Real growth is preferred because it only considers the volume produced, and this accounts for the inflation of price values in the market. With inflationary growth, the inflation and deflation of the currency value in the market are not considered, making inflationary growth an unrealistic measure of economic growth.

In conclusion, real growth considers volume to determine GDP growth, while inflation growth considers volume and market prices. Real growth is a more useful measure of economic growth because it considers the inflation or deflation effect on financial data. Inflationary growth is a good measure when the market price growth increases at the same rate as the increase in production volume growth. In an ideal economic situation, the production volume cannot grow at the same rate as the price appreciation, thus rendering inflationary growth an unfavorable measure of economic growth.

References

Ahmmed, M., Uddin, M. N., Rafiq, M. R. I., & Uddin, M. J. (2020). Inflation and economic growth linkmulti-country scenario. International Journal of Economics and Financial Issues, 10(4), 47. Web.

Feldstein, M. (2017). Underestimating the real growth of GDP, personal income, and productivity. Journal of Economic Perspectives, 31(2), 145-64. Web.

Introduction

Beyond Numbers is a new Bureau of Labor Statistics publication that explores how inflation affects the economy. The publication Exploring price increase in 2021 and previous periods of inflation studies price increases by 2021, including information on the previous periods of inflation (Bennion et al., 2022). In addition, it describes how price inflation impacted wages, employment, and other measures of economic well-being.

Discussion

The article shows how inflation affected the prices of goods and services in the United States in the past, present, and future. The article states that inflation measures the rate of change in the cost of living. It is a significant issue for consumers, businesses, and governments. Inflation is generally higher than the economic growth rate (Bennion et al., 2022). Moreover, it can harm the economy, as well as personal finances. The Federal Reserve does not target inflation directly but aims at core inflation, excluding food and energy prices from its calculations.

The article discusses how inflation affected prices in 2021 and previous periods of inflation. It helps scientists understand how important inflation is as a factor in our economy. The research gives people insight into what will happen if they do not control their spending habits and make sure they buy affordable things for their budgets. The article mentions how one should budget their money so they can afford expensive items even if the prices go up. Handling emergencies and unforeseen expenses require individuals to save money and stay updated on the long-term effects.

According to the United States Bureau of Labor Statistics, the price index for consumer goods and services increased at an annual rate of 1.3 percent in the third quarter of 2019. The price index is the ratio of prices to a base year (Bennion et al., 2022). The base year is either the beginning, middle, or end of a period that the statistician has chosen as appropriate. In this case, the base year was March 2000, which means that inflation was calculated using data from March 2000 through December 2018. The price index measures inflation by comparing current prices with those in an earlier time (usually a year). As such, it can be used to track whether prices are rising or falling over time. It also allows researchers to compare changes between different types of products and services against each other.

Conclusion

In conclusion, a number discusses several essential aspects of inflation for policymakers to consider when deciding how to address inflation. For instance, the relationship between inflation and productivity growth has been a central monetary and fiscal policy issue. In addition, inflation reduces the actual value of debt instruments, such as bonds, and thus pushes up interest rates. Conversely, rising prices reduce debt instruments real value, lowering interest rates. Thus, the impact of inflation on wages, employment, and other measures of economic well-being depends on how rapidly prices change in response to economic conditions (Greenlaw & Shapiro, 2022).

Inflation can also affect household budgets in high-income families differently than those in low-income families). According to the article, the inflation rate in the United States has been relatively stable over the past few years, but this could change in 2021. Core inflation has been slowly rising since mid-2019, when it was 3 percent (Bennion et al., 2022). It makes 2021 look like an opportune time for inflation to rise again because many goods and services are more expensive than they were three years ago.

Reference

Bennion, E., Bergqvist, T., Camp, M. K., Kowal, J., Mead, D. (2022). Exploring price increase in 2021 and previous periods of inflation. Beyond the Numbers: Prices & Spending, 11(7). Web.

Greenlaw, S. A. & Shapiro, D. (2022). Principles of Macroeconomics 2e. OpenStax.

There is a mutual relationship between business and government where the government regulates the environment in which business operates, and the businesses decide which government will be in place to influence their operations. Businesses look to the government to regulate or deregulate how they operate. This paper focuses on a news article on how raising interest rates helps fight inflation and high prices (Wile). The articles summary is based on government regulations to compact high inflation rates.

One significant way for the government to control high inflation rates is by Federal Reserve increasing the key interest rate. The article by Wile on the government fighting inflation and high prices outlines measures like Federal Reserve raising interest rates six times in 2022 to help fight inflation and get price growth under control. For example, when the interest rates are increased, the effect is passed to businesses that acquire loans via their respective banks. When businesses get loans at high-interest rates, the cost is transferred to the consumer through the high prices of goods and services.

The high-interest rates on loans limit how much businesses can borrow, limiting the flow of money into the economy hence controlling inflation. From the article, it is clear how government influences business via regulations because inflation on goods is a trade and geopolitical issue under the power of the entire government, not just the Federal Reserve (Wile). Therefore, the government is obligated to make and enforce favorable regulations that enhance business performance.

Based on the summary analysis of the article, the elected government makes policies to regulate or deregulate business operations. The effects of the policies are felt both by businesses and consumers, and they have the right to vote for the proper government that has policies to favor the operations of businesses. The article presents a perfect example of how government influences businesses.

Work Cited

Wile, Robe. How Raising Interest Rates Helps Fight Inflation and High Prices. NBC News, Web.

Introduction

Real GDP Refers to every financial activity done by the government, including consumption, investment, and transfer payment. Each form of public spending is dependent on the availability of government revenue. Most governments use different approaches, such as taxation, to generate revenues (Moore & Prichard, 2020). While some obtain it from internal sources, including customs duties, investments, and public assets, others depend on external sources such as borrowing for the revenue. Public spending can be done in two ways; through final consumption or gross capital formation. Either way, the change in public expenditure is a critical factor in fiscal policy and can be used to stabilize an economy. In addition, government spending largely relies on the budget, with a surplus budget promoting it while a deficit delimiting the same.

Public expenditure can affect the Real GDP positively or negatively. An increase in government spending will likely trigger the real GDP to take an upward trajectory, while a decrease in the same may shift the GDP downwards. Defined as the total value of all the services and goods in a country after the inflation adjustment, the real GDP is the measure of the actual total economic output of a given country. GDP percentage values for the eight years keep changing in an alternating manner. However, increasing government spending will boost the real GDP in the following ways. One, increasing consumption will motivate economic activities such as production, which in turn increases the quantity of goods produced in the country, resulting in the rise of the real GDP. Raising the expenditure influences the aggregate demand and supply, which consequently accelerate production in a country. With the simulated surplus budget, the government in question is assumed to have enough revenue in excess to initiate the spending, which will subsequently raise the aggregate demand and supply and thus catalyzing production and the consequential real GDP through increased goods and services.

Besides, public expenditure can be initiated in the form of government investment projects such as agriculture. Increasing the spending is likely to double the investments that form part of the real GDP. For instance, a decision to improve expenditure on investment projects that increase production will enhance the quantity of goods and services in the country, thereby raising the real GDP. For example, public investment in a milling factory will trigger the production of goods in the same line, raising the real GDP. As in the case of the simulated surplus budget, the government enjoys excess revenue in disposal, which can initiate the spending on investment to raise the real GDP.

Unemployment

This is another component of the economy that is subject to government spending. Improved public expenditure can decrease the unemployment rate while a decrement can advance the same. Spending through consumption is known to affect the aggregate demand and supply by catalyzing production in a country. With the increase in demand and supply and the resultant output, unemployment is likely to reduce because jobless individuals will be absorbed in production firms and activities. For example, the demand and supply for a given good and service will trigger the creation of such items. People will be needed to work in the production line, reducing unemployment.

Similarly, public expenditure through investments can affect the unemployment rate by creating jobs. By raising the spending through investments, opportunities will be created, which will consequently absorb the jobless individuals. As in the example of a factory investment, jobs will be created in the program, lowering the unemployment rate. With the simulated surplus budget, the revenue will be available for initiating investments, lowering the unemployment rate. In addition, transfer payments such as pensions can be used for personal investments such as individual businesses, which can also create small employment opportunities. Therefore, increasing spending through increased transfer payments lowers the unemployment rate. In summary, upward changes in public expenditure will negatively impact the unemployment rate.

Impact of Interest Rate on Inflation

Inflation is usually characterized by high prices of goods and services due to high demand. The increased demand is attributed to significant disposable income due to excessive borrowing. However, by increasing the interest rate, individuals will shy off from excessive loans, thereby leading to a decline in disposable income which in turn lowers individual spending and the subsequent demand and, thus, low inflation. An upward change in interest rate will reduce the demand for goods and services, which will, in turn, affect the prices downwardly, leading to a fall in inflation (Van, 2019). On the other hand, lowering the interest rate will increase inflation since many persons will be willing to borrow money from lending organizations, causing their disposable income to rise and increasing the demand rate. With the increase in demand for goods and services, the prices will automatically shoot, triggering inflation. Similarly, the change in interest rate will impact other key microeconomic indicators, such as the GDP. Increasing the interest rate discourages borrowing, which means little money in circulation and thus lowers production programs.

References

Moore, M., & Prichard, W. (2020). How can governments of low-income countries collect more tax revenue? In K. Hujo (Ed.), The politics of domestic resource mobilization for social development (pp. 109-138). Palgrave Macmillan, Cham. Web.

Van, D. D. (2019). Money supply and inflation impact on economic growth. Journal of Financial Economic Policy, 12(1), 121-136. Web.