22- Inflation

  1. What is it?
    1. Third goal of macro
    2. Defined as an overall increase in price level(Just because the price of one good goes up does not mean inflation has taken hold)
    3. Increased buying power and not enough supply(post WWII) or;
    4. No money and high supply(depression)
  2. Basket of goods
    1. Takes necessary items in an economy and tracks their price from year to year to find inflation
      1. 1st year basket costs $100, 2nd $103 = 3%
      2. Examples in U.S.
        1. Consumer price index(CPI)
        2. Producer price index
        3. Wholesaler price index
        4. GDP deflator(Not really a basket of goods) Nominal GDP/Real GDP*100=GDP deflator
          1. Not really a basket of goods
          2. Specifically takes into account each good produced domestically weighted against the market value of consumed goods
          3. This is the only approach that implicitly takes substitution effect into account
    2. Concerns
      1. May overstate inflation
        1. Boskin commission found inflation is overstated by 1%/yr
        2. Headed by Michael Boskin who was on a congressional advisory committee on CPI
        3. Criticized for understating inflation
      2. People don’t buy same goods(why buy vhs when there are DVDs)
      3. Substitution effect
    3. Negate concerns
      1. Rotate goods in basket
      2. Check the basket regularly to see if it shows an accurate picture
  3. Nature of inflation
    1. Inflation is not necessarily bad
      1. If everything goes up at the same time to the knowledge of everyone involved there is no change
      2. Not everything goes up at same time(if financing at a fixed rate the higher the inflation the better)
    2. High inflation
      1. No one know what the price of anything is
        1. Stores in hyper inflated towns had many price labels on top of each other due to rapidly adjusting prices;
        2. Used just a bar code which led to more ambiguity
        3. Too much money chasing too little goods
        4. No one can plan


    3. Policies to rectify
      1. Cut Gov’t spending
      2. Make interest rates rise
      3. Increase taxes
  4. 2 philosophies on inflation
    1. Hawks
      1. “economy works best around 0%”
      2. Able to better plan long-term
    2. Doves
      1. “small amount of inflation is ok
      2. Can make Implicit contract wages more volatile(e.g. if inflation goes up 4% give a 2% wage increase and your coming out above inflation



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