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By the end of this section, you will be able to:
  • Identify the causes and effects of inflation in various economic markets
  • Explain the significance of a converging economy

Policymakers of the high-income economies appear to have learned some lessons about fighting inflation    . First, whatever happens with aggregate supply and aggregate demand in the short run, monetary policy can be used to prevent inflation from becoming entrenched in the economy in the medium and long term. Second, there is no long-run gain to letting inflation become established. In fact, allowing inflation to become lasting and persistent poses undesirable risks and tradeoffs. When inflation is high, businesses and individuals need to spend time and effort worrying about protecting themselves against inflation, rather than seeking out better ways to serve customers. In short, the high-income economies appear to have both a political consensus to hold inflation low and the economic tools to do so.

In a number of middle- and low-income economies around the world, inflation is far from a solved problem. In the early 2000s, Turkey experienced inflation of more than 50% per year for several years. Belarus had inflation of about 100% per year from 2000 to 2001. From 2008 to 2010, Venezuela and Myanmar had inflation rates of 20% to 30% per year. Indonesia, Iran, Nigeria, the Russian Federation, and Ukraine all had double-digit inflation for most of the years from 2000 to 2010. Zimbabwe had hyperinflation, with inflation rates that went from more than 100% per year in the mid-2000s to a rate of several million percent in 2008.

In these countries, the problem of very high inflation generally arises from huge budget deficits, which are financed by the government printing its domestic currency. This is a case of “too much money chasing too few goods.” In the case of Zimbabwe, the government covered its widening deficits by printing ever higher currency notes, including a $100 trillion bill. By late 2008, the money was nearly worthless, which led Zimbabwe to adopt the U.S. dollar, immediately halting their hyperinflation. In some countries, the central bank makes loans to politically favored firms, essentially printing money to do so, and this too leads to higher inflation.

A number of countries have managed to sustain solid levels of economic growth for sustained periods of time with levels of inflation that would sound high by recent U.S. standards, like 10% to 30% per year. In such economies, most contracts, wage levels, and interest rates are indexed to inflation. Indexing wage contracts and interest rates means that they will increase when inflation increases to retain purchasing power. When wages do not rise as price levels rise, this leads to a decline in the real wage rate and a decrease in the standard of living. Likewise, interest rates that are not indexed mean that the lenders of money will be paid back in devalued currency and will also lose purchasing power on monies that were lent. It is clearly possible—and perhaps sometimes necessary—for a converging economy    (the economy of a country that demonstrates the ability to catch up to the technology leaders) to live with a degree of uncertainty over inflation that would be politically unacceptable in the high-income economies.

Concepts and summary

Most high-income economies have learned that their central banks can control inflation in the medium and the long term. In addition, they have learned that inflation has no long-term benefits but potentially substantial long-term costs if it distracts businesses from focusing on real productivity gains. However, smaller economies around the world may face more volatile inflation because their smaller economies can be unsettled by international movements of capital and goods.

Problems

Retrieve inflation data from The World Bank data base (http://databank.worldbank.org/data/home.aspx) for India, Spain, and South Africa for 2008–2013. Prepare a chart that compares India, Spain, and South Africa based on the data. Describe the key differences between the countries. Rank these countries as high-, medium-, and low-income. Explain what is surprising or expected about the data.

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Questions & Answers

what is the determination of aggregate demand?
Maddy Reply
classical dichotomy and its components?
Romaisa Reply
what will happen to the demand curve when there is an inflation in an economy
Hamza Reply
From my view, I think the demand curve will shift inwards.
Bobo
now it depends on what kind of inflation it is, depending on the type of inflation the movement of the demand curve can be stated.
Munimu
yes it depends on the cause for inflation. if it caused by maybe an increase in money supply, the effect is neutral in the long term, therefore there are no effects on total output in the economy, except for an increase in price
Lucas
but short term in general i think you could expect the demand curve to shift inwards as consumers experience a decrease in real income
Lucas
source of capital for the sole trader
Dogbey Reply
borrowing from relatives, government grants, bank loans, personal savings, credit card etc.
Munimu
Suppose you are holding 2000 in a checking account and the price level decrease by 20 %how much it will affect your purchasing power and why
Iqra Reply
Hi Iqra, will answer your question soon.
Aleem
2000*0.2= 400 2000-400= 1600
Munimu
1600
Munimu
a price level decrease is deflation. it means you'll be able to afford to buy more with your 2000 and your real income becomes 2000÷(100-20)=2500
Lucas
the amount will decrease to 1600 and you can't be able to buy over this amount
Agogo
As an economist student discuss how the pandemic covid19 can affect the aggregate demand and aggregate supply thereby leading to decrease in GDP and standard of living of citizens of nigeria
Fadila Reply
hi how can you help me?
qusai Reply
can you send me the notes
Mohd
hello is what are you talking about?
Mousa
unemployment and low inflation    .
Abdirizaq Reply
Structure/Organization Of The Federal Reserve
Abdirizaq
sorry guys in macroeconomics what is different between inflation and intrest rate? please example for pandemic related maybe?
Siyanda
hello
Ramu
Is this Aap for class 11 and 12 only not for graduation?
ankit Reply
yeah like for du MA entrance
VAISHALI
okay
ankit
Aree i m also asking
VAISHALI
for du MA entrance. u shouldn't rely on app. Go for SAURABH SIR notes. available on flipkart.
Saurabh
ohh thanks
VAISHALI
pleasure
Saurabh
ooh
ankit
what is inflation
Bright Reply
hike in price
shola
situation of rise in price with the fall in purchasing power of money
Almina
cycle of corruption
Omkar
rise in price of a Nation economy in terms of trade
adebiyi
what is distruptive international trade?
NOEL
meaning of inflation
Jayakumar Reply
increase in general prices level in an economy.
Tayyab
increase in general price level
Abu
The fall in standard of living because goods and services become expensive.
NOEL
what is value added and how is it used in calculating GDP
Benedicta Reply
value added is final price of output minus cost of production. For example, let's say you make a shirt with raw materials that cost $20, and then sell the shirt for $35 added value would be 35-20=15. In calculating GDP, it is used to avoid double counting goods. Exp. eggs individually and in bread.
julian
as the price of tickets rises from $200 to $250, what is the price elasticity of demand for business travelers, vacationers using midpoint method
Buumba Reply
$300
Jb
@jb how do uget $300
Jeff
It means you are measuring the cost against availability.
Muyiwa
Explain how income taxes and transfer payments are used to stabilize the economy
Nakagwa Reply
reduce demand on scarce resources by reducing money supply.
NOEL
sketch the graph of supply curve
Isamole Reply

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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