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A preview of policy discussions of inflation

This chapter has focused on how inflation is measured, historical experience with inflation, how to adjust nominal variables into real ones, how inflation affects the economy, and how indexing works. The causes of inflation have barely been hinted at, and government policies to deal with inflation have not been addressed at all. These issues will be taken up in depth in other chapters. However, it is useful to offer a preview here.

The cause of inflation can be summed up in one sentence: Too many dollars chasing too few goods. The great surges of inflation early in the twentieth century came after wars, which are a time when government spending is very high, but consumers have little to buy, because production is going to the war effort. Governments also commonly impose price controls during wartime. After the war, the price controls end and pent-up buying power surges forth, driving up inflation. On the other hand, if too few dollars are chasing too many goods, then inflation will decline or even turn into deflation. Therefore, slowdowns in economic activity, as in major recessions and the Great Depression, are typically associated with a reduction in inflation or even outright deflation.

The policy implications are clear. If inflation is to be avoided, the amount of purchasing power in the economy must grow at roughly the same rate as the production of goods. Macroeconomic policies that the government can use to affect the amount of purchasing power—through taxes, spending, and regulation of interest rates and credit—can thus cause inflation to rise or reduce inflation to lower levels.

A $550 million loaf of bread?

As we will learn in Money and Banking , the existence of money provides enormous benefits to an economy. In a real sense, money is the lubrication that enhances the workings of markets. Money makes transactions easier. It allows people to find employment producing one product, then use the money earned to purchase the other products they need to live on. However, too much money in circulation can lead to inflation. Extreme cases of governments recklessly printing money lead to hyperinflation. Inflation reduces the value of money. Hyperinflation, because money loses value so quickly, ultimately results in people no longer using money. The economy reverts to barter, or it adopts another country’s more stable currency, like U.S. dollars. In the meantime, the economy literally falls apart as people leave jobs and fend for themselves because it is not worth the time to work for money that will be worthless in a few days.

Only national governments have the power to cause hyperinflation. Hyperinflation typically happens when government faces extraordinary demands for spending, which it cannot finance by taxes or borrowing. The only option is to print money—more and more of it. With more money in circulation chasing the same amount (or even less) goods and services, the only result is higher and higher prices until the economy and/or the government collapses. This is why economists are generally wary of letting inflation get out of control.

Key concepts and summary

A payment is said to be indexed if it is automatically adjusted for inflation. Examples of indexing in the private sector include wage contracts with cost-of-living adjustments (COLAs) and loan agreements like adjustable-rate mortgages (ARMs). Examples of indexing in the public sector include tax brackets and Social Security payments.

Problems

If inflation rises unexpectedly by 5%, indicate for each of the following whether the economic actor is helped, hurt, or unaffected:

  1. A union member with a COLA wage contract
  2. Someone with a large stash of cash in a safe deposit box
  3. A bank lending money at a fixed rate of interest
  4. A person who is not due to receive a pay raise for another 11 months

Got questions? Get instant answers now!

Rosalie the Retiree knows that when she retires in 16 years, her company will give her a one-time payment of $20,000. However, if the inflation rate is 6% per year, how much buying power will that $20,000 have when measured in today’s dollars? Hint : Start by calculating the rise in the price level over the 16 years.

Got questions? Get instant answers now!

References

Wines, Michael. “How Bad is Inflation in Zimbabwe?” The New York Times , May 2, 2006. http://www.nytimes.com/2006/05/02/world/africa/02zimbabwe.html?pagewanted=all&_r=0.

Hanke, Steve H. “R.I.P. Zimbabwe Dollar.” CATO Institute . Accessed December 31, 2013. http://www.cato.org/zimbabwe.

Massachusetts Institute of Technology. 2015. "Billion Prices Project." Accessed March 4, 2015. http://bpp.mit.edu/usa/.

Questions & Answers

where we get a research paper on Nano chemistry....?
Maira Reply
what are the products of Nano chemistry?
Maira Reply
There are lots of products of nano chemistry... Like nano coatings.....carbon fiber.. And lots of others..
learn
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Google
da
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Bhagvanji
Preparation and Applications of Nanomaterial for Drug Delivery
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revolt
da
Application of nanotechnology in medicine
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RAW Reply
please someone correct me if I'm wrong but I think one can use nanoparticles, specially silver nanoparticles for water treatment.
Damian
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Professor
I think
Professor
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Alexandre
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Brian Reply
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Rafiq
industrial application...? mmm I think on the medical side as drug carrier, but you should go deeper on your research, I may be wrong
Damian
How we are making nano material?
LITNING Reply
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What is meant by 'nano scale'?
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LITNING
scanning tunneling microscope
Sahil
how nano science is used for hydrophobicity
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Do u think that Graphene and Fullrene fiber can be used to make Air Plane body structure the lightest and strongest. Rafiq
Rafiq
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Rafiq
if virus is killing to make ARTIFICIAL DNA OF GRAPHENE FOR KILLED THE VIRUS .THIS IS OUR ASSUMPTION
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analytical skills graphene is prepared to kill any type viruses .
Anam
Any one who tell me about Preparation and application of Nanomaterial for drug Delivery
Hafiz
what is Nano technology ?
Bob Reply
write examples of Nano molecule?
Bob
The nanotechnology is as new science, to scale nanometric
brayan
nanotechnology is the study, desing, synthesis, manipulation and application of materials and functional systems through control of matter at nanoscale
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Damian Reply
what king of growth are you checking .?
Renato
What fields keep nano created devices from performing or assimulating ? Magnetic fields ? Are do they assimilate ?
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?
Kyle
yes I'm doing my masters in nanotechnology, we are being studying all these domains as well..
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why?
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what school?
Kyle
biomolecules are e building blocks of every organics and inorganic materials.
Joe
Equilibrium price is a stable price and it must stay.discuss
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Card 14 / 21: What are the similarities between a consumer’s budget constraint and society’s production possibilities frontier, not just graphically but analytically?
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Source:  OpenStax, Principles of macroeconomics for ap® courses. OpenStax CNX. Aug 24, 2015 Download for free at http://legacy.cnx.org/content/col11864/1.2
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