Inflation and by afr15630



    A.V. Vedpuriswar

  Feb10, 2008

   This is the process by which the price level rises
    and money loses value.
   There are two kinds of inflation:
   a) Demand pull
   b) Cost push
                 Demand pull inflation

    Demand pull inflation may be due to :
a)   Increase in money supply
b)   Increase in government purchases
c)   Increase in exports
                       Cost push

    Cost push inflation may arise because of :
a)   Increase in money wage rates
b)   Increase in money prices of raw materials.
                   Discussion question

   Why is inflation bad?
    Unanticipated inflation is bad because it makes the
     economy behave like a giant casino.
    Gains and losses occur because of unpredictable
     changes in the value of money.
    If the value of money varies unpredictably over time,
     the quantity of goods and services that money will buy
     will also fluctuate unpredictably.
    Resources are also diverted from productive activities
     to forecasting inflation.
    Unanticipated inflation leads to :
a)   Redistribution of income, borrowers and lenders
b)   Too much or too little lending or borrowing
   Consumer Price Index (CPI) is one of the most frequently
    used statistics for identifying periods of inflation or
   Large rises in CPI during a short period of time typically
    denote periods of inflation.
   The U.S. Bureau of Labor Statistics measures two kinds
    of CPI statistics:
      CPI for urban wage earners and clerical workers (CPI-
      The chained CPI for all urban consumers (C-CPI-U).
   Of the two types of CPI, the C-CPI-U is a
    better representation of the general public, because it
    accounts for about 87% of the population.
   The CPI uses a base year and indexes current year
    prices based on the base year's values.
                  Headline Inflation

   The raw inflation figure as reported through the
    Consumer Price Index (CPI) that is released monthly
    by the Bureau of Labor Statistics.
   Also known as "top-line inflation".
   The headline figure is not adjusted for seasonality or
    for the often-volatile elements of food and energy
    Inflation is usually quoted on an annualized basis.
   A monthly headline figure of 4% inflation equates to a
    monthly rate that, if repeated for 12 months, would
    create 4% inflation for the year.
   Comparisons of headline inflation are typically made
    on a year-over-year basis.
                   Core Inflation
   While headline inflation tends to get the most
    attention in the media, core inflation is often
    considered the more valuable metric to follow.
   Core inflation removes the CPI components that can
    exhibit large amounts of volatility month to month,ie
    those that can have temporary price shocks .
   Core inflation usually excludes energy and food
   Other methods of calculations include the outliers
   The products that have had the largest price changes
    are taken out.
                     Hyper inflation

   Extremely rapid or out of control inflation.
   There is no precise numerical definition to hyperinflation.
   Price increases are so out of control that the concept of
    inflation is meaningless.
   The most famous example of hyperinflation occurred in
    Germany between January 1922 and November 1923.
    By some estimates, the average price level increased by a
    factor of 20 billion!

    A condition of slow economic growth and relatively high
    unemployment accompanied by inflation.
   This happened to a great extent during the 1970s, when
    world oil prices rose dramatically, fueling sharp inflation in
    developed countries.
   Are we seeing that about to happen in early 2008?
   At least some central banks have expressed concern over
    inflation even as the global economy seems to be slowing
        Unemployment and the labour force

   Labour force or workforce - The number of people
    employed and self-employed plus those
    unemployed but ready and able to work.
   Three factors affect the size of the labour force:
     Population
     Migration
     Labour force participation in economic activity.
   Birth rates in most industrial countries fell to
    replacement levels or lower in the 1980s.
   This implies an older workforce and higher old-age
    dependency rates (the number of retired people as
    a percentage of the population of working age) in
    the future.
   By 2010, 15-20% of the population in industrial
    economies will be over 65 years of age.
   On the other hand, developing countries have
    young populations with up to 50% under 15 years.
   This suggests an expanding working-age
    population with potential problems for housing and
    job creation.
   .
   In the industrial countries, inflows of foreign workers
    increased since the late 1980s and a substantial number
    of illegal immigrants were granted amnesty in America,
    France, Italy and Spain.
   Foreign-born persons account for over 5% of the labour
    force in America, Germany and France; around 20% in
    Switzerland and Canada; and over 25% in Australia
    German unification boosted that country's productive
   Wealthier developing countries, especially oil producers,
    have large proportions of foreigners in their labour forces.

   However, large numbers of refugees seeking asylum can
    have significant adverse effects on income per head.
   Participation rates (the labour force as a percentage
    of the total population) generally increased in the
    1980s and 1990s.
   Earlier retirement for men, especially in France,
    Finland and the Netherlands, was generally offset by
    more married women entering the labour force,
    especially in America, Australia, Britain, New Zealand
    and Scandinavia.
   Women account for a smaller proportion of the
    workforce in Muslim countries (20%).
   But they account for a greater proportion in Africa (up
    to 50%) where they traditionally work on the land.
               The unemployment rate

    Usually defined as a percentage of the labour
    force (the employed plus the unemployed).
   There are national variations :
     Germany excludes the self-employed from the labour
     Belgium produces two rates expressing unemployment
      as a percentage of both the total and the insured labour
     By changing the definition, the unemployment rate can
      be moved up or, down by several percentage points.
            Types of unemployment

   Frictional : arises from normal labour turnover, ie
    people entering and leaving the labour force.
      Generous unemployment compensation leads to
       high frictional unemployment.
      European countries like France fall in this
   Structural : arises due to changes in technology,
    international competition, etc.
      Arises due to skill obsolescence or lack of
   Cyclical : fluctuates with the business cycle.
      Increases during a recession and falls during an
                    Full employment

    The natural rate of unemployment is that rate at
     which there is no cyclical unemployment, ie all the
     unemployment is structural or frictional.
    Full employment occurs when the unemployment
     rate equals the natural rate of unemployment.
    Unemployment rate fluctuates because of :
a)   Job search
b)   Job rationing
c)   Sticky wages
               Job rationing

Job rationing is the practice of paying employed
people a wage that creates an excess supply of
labour, a shortage of jobs and increases the
natural rate of unemployment.
It arises because of :
A) Efficiency wage : The company may pay
more to attract and retain talent.
B) Insider interest : Insiders would not like
outsiders to be paid lower wages.
C) Minimum wage : The government may
specify minimum wages.
                 Discussion topic

   Unemployment rates in Europe have tended to be
    higher than in the US. Why is this so?
                      Phillips curve

   In 1958, a New Zealand economist , A.W.H. Phillips
    proposed that there was a trade-off between inflation and
   The lower the unemployment rate, the higher was the rate
    of inflation.
   Governments simply had to choose the right balance
    between the two evils.
   Economies did seem to work like this in the 1950s and
    1960s, but then the relationship broke down.
    NAIRU(Non Accelerating inflation rate of

   Now economists prefer to talk about the NAIRU, the
    lowest rate of unemployment at which inflation does
    not accelerate.
   The lowest rate of unemployment at which the jobs
    market can be in stable equilibrium.
   When unemployment is above this rate, demand can
    potentially be increased to bring it to the natural rate,
    but attempting to lower it even further will only cause
    inflation to accelerate.
        The Keynesians and the Monetarists
   Keynesians, assumed that the economy would always have
    some slack.
   The government could lower the rate of unemployment if it
    was willing to accept a little more inflation.
   However, economists such as Milton Friedman argued that
    the economy of left to itself would adjust to full employment.
   The supposed inflation-for-jobs trade-off was in fact a trap.
    Governments that tolerated higher inflation in the hope of
    lowering unemployment would find that joblessness dipped
    only briefly before returning to its previous level, while
    inflation would rise and stay high.
   Instead, they argued, unemployment has an equilibrium or
    natural rate, determined not by the amount of demand in an
    economy but by the structure of the labour market.
   They stressed the importance of flexible labour markets.
Unemployment data
Headline inflation data
Core inflation data
Commodity price data

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