OverviewThe causes of inflationTypes of inflationThe costs of inflationWays to control inflationConsumer Price Index - CPI

Inflation: Its Causes and CostsInflation is a sustained increase in the price

level. It is a continuous increase versus a “once-and-for-all” increase in prices.

Inflation deals with the increase in the average of prices and not just significant increases in the price of a few goods.

Types of inflationDemand –Pull Inflation

Cost Push inflation

Cost – push inflationSustained increase in price of goods and services, caused by the passing off of increased production costs to the consumers by the producers. Also called cost inflation, it is the opposite of demand-pull inflation.

Demand – Pull InflationSustained increase in the prices of goods and services resulting from a high demand, stimulated by easy credit and hire purchase offers accompanied by insufficient supplies. In general, more inflation is caused by demand-pull factors than by cost-push factors. Also called demand inflation, it is the opposite of cost-push inflation.

Monetary policy DefinitionEconomic strategy chosen by a government

in deciding expansion or contraction in the country's money-supply. Applied usually through the central bank,

Monetary PolicyMonetary policy employs three major tools:1. Buying or selling national debt. 2. Changing credit restrictions.3. Changing the interest rates by changing

reserve requirements.

Monetary policy plays the dominant role in control of the aggregate-demand and, by extension, of inflation in an economy.

National DebtTotal outstanding borrowings of a central government comprising of internal (owing to national creditors) and external (owing to foreign creditors) debt incurred in financing its expenditure.

National DebtNational debt is divided generally into three

categories: 1. Floating debt, short term borrowings such as

treasury bills, various ways-and-means advances, and borrowings from the central bank.

2. Funded debt, short-term debt converted into long-term debt.

3. Unfunded debt, national savings certificates, savings bonds, premium bonds, and securities repayable in foreign exchange (payment of which affects the country's balance of payments).

Reserve RequirementsMinimum amount of cash or cash-equivalents (computed as a percentage of deposits) that banks and other depository institutions, are required by law to keep on hand, and which may not be used for lending or investing.

Reserve RequirementsReserve requirements serve as :

1. Safeguard against a sudden and inordinate demand for withdrawals (as in a run on a bank).

2. Control mechanism for injecting cash (liquidity) into, or withdrawing it from, an economy.

Money Supply and Money DemandMoney Supply is a variable of the Reserve Bank

of a country. Through instruments such as open market operations, the RB directly controls the quantity of money supplied.

Money Demand has several determinants including:interest ratesaverage level of prices in the economy

Money Supply and Money DemandPeople hold money because it is the medium

of exchange. The amount of money people choose to hold depends on the prices of the goods and services.

In the long-run, the overall level of prices adjusts to the level at which the demand for money equals the supply.

HyperinflationHyperinflation is inflation that exceeds 50

percent per month. Hyperinflation in some countries is caused

because the government prints too much money to pay for their spending.

Zimbabwe’s inflation rate went up to 3,731.9% !

ObjectivesTo explain how index numbers are calculatedTo explain their limitations in calculating

inflation

Consumer Price Index (CPI)

Used to calculate inflation by measuring the price changes in a basket of goods in comparison with a base year.

Allows comparisons across both time and countries.

How does this link with inflation?WeighingChanges over timeIs only an average.What should be included?

Problems with measuring the CPIBasket of goods represents typical household and may not represent

ALL households.There may be errors in the data as well as the collecting of the data.Changes needs to be made regularly to reflect changing spending

patternsDifferent countries measure inflation differently.Prices may vary for a variety of reasons not just inflation.CPI only measures changes ion consumer prices.