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?• 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?• 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...
• 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?
• 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)• 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?
• Borrowers at fixed rates (lower than the rate of inflation)
• Lenders at adjustable rates
Conclusions about inflation
• Inflation tends to arbitrarily redistribute income
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
• 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)• THEREFORE: Savings and
Investment are DISCOURAGED by our own tax system
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)
• Dis-inflation: a sustained period of little or no inflation
• Deflation: sustained decreases in the price level
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
• 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?
• 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