Inflation

Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.[1][2][3][4] When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy.[5][6] The measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time.[7] The opposite of inflation is deflation.

Inflation affects economies in various positive and negative ways. The negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include reducing unemployment due to nominal wage rigidity,[8] allowing the central bank more leeway in carrying out monetary policy, encouraging loans and investment instead of money hoarding, and avoiding the inefficiencies associated with deflation.

Economists generally believe that the high rates of inflation and hyperinflation are caused by an excessive growth of the money supply.[9] Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities.[10] However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.[11][12]

Today, most economists favor a low and steady rate of inflation.[13] Low (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy.[14] The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control monetary policy through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.[15]

History

US Historical Inflation Ancient
US historical inflation and deflation (in green) from the mid-17th century to the end of the 20th.

Historically, rapid increases in the quantity of money or in the overall money supply have occurred in many different societies throughout history, changing with different forms of money used.[16][17] For instance, when gold was used as currency, the government could collect gold coins, melt them down, mix them with other metals such as silver, copper, or lead, and reissue them at the same nominal value. By diluting the gold with other metals, the government could issue more coins without increasing the amount of gold used to make them. When the cost of each coin is lowered in this way, the government profits from an increase in seigniorage.[18] This practice would increase the money supply but at the same time the relative value of each coin would be lowered. As the relative value of the coins becomes lower, consumers would need to give more coins in exchange for the same goods and services as before. These goods and services would experience a price increase as the value of each coin is reduced.[19]

Song Dynasty China introduced the practice of printing paper money to create fiat currency.[20] During the Mongol Yuan Dynasty, the government spent a great deal of money fighting costly wars, and reacted by printing more money, leading to inflation.[21] Fearing the inflation that plagued the Yuan dynasty, the Ming Dynasty initially rejected the use of paper money, and reverted to using copper coins.[22]

Historically, large infusions of gold or silver into an economy also led to inflation. From the second half of the 15th century to the first half of the 17th, Western Europe experienced a major inflationary cycle referred to as the "price revolution",[23][24] with prices on average rising perhaps sixfold over 150 years. This was largely caused by the sudden influx of gold and silver from the New World into Habsburg Spain.[25] The silver spread throughout a previously cash-starved Europe and caused widespread inflation.[26][27] Demographic factors also contributed to upward pressure on prices, with European population growth after depopulation caused by the Black Death pandemic.

By the nineteenth century, economists categorized three separate factors that cause a rise or fall in the price of goods: a change in the value or production costs of the good, a change in the price of money which then was usually a fluctuation in the commodity price of the metallic content in the currency, and currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency. Following the proliferation of private banknote currency printed during the American Civil War, the term "inflation" started to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable banknotes outstripped the quantity of metal available for their redemption. At that time, the term inflation referred to the devaluation of the currency, and not to a rise in the price of goods.[28]

This relationship between the over-supply of banknotes and a resulting depreciation in their value was noted by earlier classical economists such as David Hume and David Ricardo, who would go on to examine and debate what effect a currency devaluation (later termed monetary inflation) has on the price of goods (later termed price inflation, and eventually just inflation).[29]

The adoption of fiat currency by many countries, from the 18th century onwards, made much larger variations in the supply of money possible. Rapid increases in the money supply have taken place a number of times in countries experiencing political crises, producing hyperinflations – episodes of extreme inflation rates much higher than those observed in earlier periods of commodity money. The hyperinflation in the Weimar Republic of Germany is a notable example. Currently, the hyperinflation in Venezuela is the highest in the world, with an annual inflation rate of 833,997% as of October 2018.[30]

However, since the 1980s, inflation has been held low and stable in countries with strong independent central banks. This has led to a moderation of the business cycle and a reduction in variation in most macroeconomic indicators - an event known as the Great Moderation.[31]

Related definitions

The term "inflation" originally referred to a rise in the general price level caused by an imbalance between the quantity of money and trade needs.[32] However, it is common for economists today to use the term "inflation" to refer to a rise in the price level. An increase in the money supply may be called monetary inflation, to distinguish it from rising prices, which may also for clarity be called "price inflation".[28] Economists generally agree that in the long run, inflation is caused by increases in the money supply.[33]

Conceptually, inflation refers to the general trend of prices, not changes in any specific price. For example, if people choose to buy more cucumbers than tomatoes, cucumbers consequently become more expensive and tomatoes cheaper. These changes are not related to inflation; they reflect a shift in tastes. Inflation is related to the value of currency itself. When currency was linked with gold, if new gold deposits were found, the price of gold and the value of currency would fall, and consequently prices of all other goods would become higher.[34]

Other economic concepts related to inflation include: deflation – a fall in the general price level; disinflation – a decrease in the rate of inflation; hyperinflation – an out-of-control inflationary spiral; stagflation – a combination of inflation, slow economic growth and high unemployment; reflation – an attempt to raise the general level of prices to counteract deflationary pressures; and asset price inflation – a general rise in the prices of financial assets without a corresponding increase in the prices of goods or services.

Inflation expectations

Inflation expectations or expected inflation is the rate of inflation that is anticipated for some period of time in the foreseeable future. There are two major approaches to modeling the formation of inflation expectations. Adaptive expectations models them as a weighted average of what was expected one period earlier and the actual rate of inflation that most recently occurred. Rational expectations models them as unbiased, in the sense that the expected inflation rate is not systematically above or systematically below the inflation rate that actually occurs.

A long-standing survey of inflation expectations is the University of Michigan survey.[35]

Inflation expectations affect the economy in several ways. They are more or less built into nominal interest rates, so that a rise (or fall) in the expected inflation rate will typically result in a rise (or fall) in nominal interest rates, giving a smaller effect if any on real interest rates. In addition, higher expected inflation tends to be built into the rate of wage increases, giving a smaller effect if any on the changes in real wages. Moreover, the response of inflationary expectations to monetary policy can influence the division of the effects of policy between inflation and unemployment (see Monetary policy credibility).

Measures

FRED graph US CPI for All Urban Consumers 1969–2019
US Consumer Price Index (CPI) 1969 to 2019, obtained from the FRED Database. Inflation is the increase in the CPI.

Since there are many possible measures of the price level, there are many possible measures of price inflation. Most frequently, the term "inflation" refers to a rise in a broad price index representing the overall price level for goods and services in the economy. The Consumer Price Index (CPI), the Personal consumption expenditures price index (PCEPI) and the GDP deflator are some examples of broad price indices. However, "inflation" may also be used to describe a rising price level within a narrower set of assets, goods or services within the economy, such as commodities (including food, fuel, metals), tangible assets (such as real estate), financial assets (such as stocks, bonds), services (such as entertainment and health care), or labor. Although the values of capital assets are often casually said to "inflate," this should not be confused with inflation as a defined term; a more accurate description for an increase in the value of a capital asset is appreciation. The Reuters-CRB Index (CCI), the Producer Price Index, and Employment Cost Index (ECI) are examples of narrow price indices used to measure price inflation in particular sectors of the economy. Core inflation is a measure of inflation for a subset of consumer prices that excludes food and energy prices, which rise and fall more than other prices in the short term. The Federal Reserve Board pays particular attention to the core inflation rate to get a better estimate of long-term future inflation trends overall.[36]

The inflation rate is most widely calculated by calculating the movement or change in a price index, typically the consumer price index.[37] The inflation rate is the percentage change of a price index over time. The Retail Prices Index is also a measure of inflation that is commonly used in the United Kingdom. It is broader than the CPI and contains a larger basket of goods and services.

To illustrate the method of calculation, in January 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the course of the year is: The resulting inflation rate for the CPI in this one-year period is 4.28%, meaning the general level of prices for typical U.S. consumers rose by approximately four percent in 2007.[38]

Other widely used price indices for calculating price inflation include the following:

  • Producer price indices (PPIs) which measures average changes in prices received by domestic producers for their output. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any eventual increase in the CPI. Producer price index measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" to consumers, or it could be absorbed by profits, or offset by increasing productivity. In India and the United States, an earlier version of the PPI was called the Wholesale price index.
  • Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.
  • Core price indices: because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore, most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy.

Other common measures of inflation are:

  • GDP deflator is a measure of the price of all the goods and services included in gross domestic product (GDP). The US Commerce Department publishes a deflator series for US GDP, defined as its nominal GDP measure divided by its real GDP measure.

  • Regional inflation The Bureau of Labor Statistics breaks down CPI-U calculations down to different regions of the US.
  • Historical inflation Before collecting consistent econometric data became standard for governments, and for the purpose of comparing absolute, rather than relative standards of living, various economists have calculated imputed inflation figures. Most inflation data before the early 20th century is imputed based on the known costs of goods, rather than compiled at the time. It is also used to adjust for the differences in real standard of living for the presence of technology.
  • Asset price inflation is an undue increase in the prices of real or financial assets, such as stock (equity) and real estate. While there is no widely accepted index of this type, some central bankers have suggested that it would be better to aim at stabilizing a wider general price level inflation measure that includes some asset prices, instead of stabilizing CPI or core inflation only. The reason is that by raising interest rates when stock prices or real estate prices rise, and lowering them when these asset prices fall, central banks might be more successful in avoiding bubbles and crashes in asset prices.

Issues in measuring

Measuring inflation in an economy requires objective means of differentiating changes in nominal prices on a common set of goods and services, and distinguishing them from those price shifts resulting from changes in value such as volume, quality, or performance. For example, if the price of a can of corn changes from $0.90 to $1.00 over the course of a year, with no change in quality, then this price difference represents inflation. This single price change would not, however, represent general inflation in an overall economy. To measure overall inflation, the price change of a large "basket" of representative goods and services is measured. This is the purpose of a price index, which is the combined price of a "basket" of many goods and services. The combined price is the sum of the weighted prices of items in the "basket". A weighted price is calculated by multiplying the unit price of an item by the number of that item the average consumer purchases. Weighted pricing is a necessary means to measuring the impact of individual unit price changes on the economy's overall inflation. The Consumer Price Index, for example, uses data collected by surveying households to determine what proportion of the typical consumer's overall spending is spent on specific goods and services, and weights the average prices of those items accordingly. Those weighted average prices are combined to calculate the overall price. To better relate price changes over time, indexes typically choose a "base year" price and assign it a value of 100. Index prices in subsequent years are then expressed in relation to the base year price.[15] While comparing inflation measures for various periods one has to take into consideration the base effect as well.

Inflation measures are often modified over time, either for the relative weight of goods in the basket, or in the way in which goods and services from the present are compared with goods and services from the past. Over time, adjustments are made to the type of goods and services selected to reflect changes in the sorts of goods and services purchased by 'typical consumers'. New products may be introduced, older products disappear, the quality of existing products may change, and consumer preferences can shift. Both the sorts of goods and services which are included in the "basket" and the weighted price used in inflation measures will be changed over time to keep pace with the changing marketplace.

Inflation numbers are often seasonally adjusted to differentiate expected cyclical cost shifts. For example, home heating costs are expected to rise in colder months, and seasonal adjustments are often used when measuring for inflation to compensate for cyclical spikes in energy or fuel demand. Inflation numbers may be averaged or otherwise subjected to statistical techniques to remove statistical noise and volatility of individual prices.

When looking at inflation, economic institutions may focus only on certain kinds of prices, or special indices, such as the core inflation index which is used by central banks to formulate monetary policy.

Most inflation indices are calculated from weighted averages of selected price changes. This necessarily introduces distortion, and can lead to legitimate disputes about what the true inflation rate is. This problem can be overcome by including all available price changes in the calculation, and then choosing the median value.[39] In some other cases, governments may intentionally report false inflation rates; for instance, during the presidency of Cristina Kirchner (2007–2015) the government of Argentina was criticised for manipulating economic data, such as inflation and GDP figures, for political gain and to reduce payments on its inflation-indexed debt.[40][41]

Causes

Historically, a great deal of economic literature was concerned with the question of what causes inflation and what effect it has. There were different schools of thought as to the causes of inflation. Most can be divided into two broad areas: quality theories of inflation and quantity theories of inflation.

The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the quantity equation of money that relates the money supply, its velocity, and the nominal value of exchanges.

Currently, the quantity theory of money is widely accepted as an accurate model of inflation in the long run. Consequently, there is now broad agreement among economists that in the long run, the inflation rate is essentially dependent on the growth rate of the money supply relative to the growth of the economy. However, in the short and medium term inflation may be affected by supply and demand pressures in the economy, and influenced by the relative elasticity of wages, prices and interest rates.[42]

The question of whether the short-term effects last long enough to be important is the central topic of debate between monetarist and Keynesian economists. In monetarism prices and wages adjust quickly enough to make other factors merely marginal behavior on a general trend-line. In the Keynesian view, prices and wages adjust at different rates, and these differences have enough effects on real output to be "long term" in the view of people in an economy.

Keynesian view

Keynesian economics proposes that changes in the money supply do not directly affect prices in the short run, and that visible inflation is the result of pressures in the economy expressing themselves in prices.

There are three major types of inflation, as part of what Robert J. Gordon calls the "triangle model":[43]

  • Demand-pull inflation is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation encourages economic growth since the excess demand and favourable market conditions will stimulate investment and expansion.
  • Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices. Another example stems from unexpectedly high insured losses, either legitimate (catastrophes) or fraudulent (which might be particularly prevalent in times of recession). High inflation can prompt employees to demand rapid wage increases, to keep up with consumer prices. In the cost-push theory of inflation, rising wages in turn can help fuel inflation. In the case of collective bargaining, wage growth will be set as a function of inflationary expectations, which will be higher when inflation is high. This can cause a wage spiral.[44] In a sense, inflation begets further inflationary expectations, which beget further inflation.
  • Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Demand-pull theory states that inflation accelerates when aggregate demand increases beyond the ability of the economy to produce (its potential output). Hence, any factor that increases aggregate demand can cause inflation.[45] However, in the long run, aggregate demand can be held above productive capacity only by increasing the quantity of money in circulation faster than the real growth rate of the economy. Another (although much less common) cause can be a rapid decline in the demand for money, as happened in Europe during the Black Death, or in the Japanese occupied territories just before the defeat of Japan in 1945.

The effect of money on inflation is most obvious when governments finance spending in a crisis, such as a civil war, by printing money excessively. This sometimes leads to hyperinflation, a condition where prices can double in a month or less. The money supply is also thought to play a major role in determining moderate levels of inflation, although there are differences of opinion on how important it is. For example, monetarist economists believe that the link is very strong; Keynesian economists, by contrast, typically emphasize the role of aggregate demand in the economy rather than the money supply in determining inflation. That is, for Keynesians, the money supply is only one determinant of aggregate demand.

Some Keynesian economists also disagree with the notion that central banks fully control the money supply, arguing that central banks have little control, since the money supply adapts to the demand for bank credit issued by commercial banks. This is known as the theory of endogenous money, and has been advocated strongly by post-Keynesians as far back as the 1960s. This position is not universally accepted – banks create money by making loans, but the aggregate volume of these loans diminishes as real interest rates increase. Thus, central banks can influence the money supply by making money cheaper or more expensive, thus increasing or decreasing its production.

A fundamental concept in inflation analysis is the relationship between inflation and unemployment, called the Phillips curve. This model suggests that there is a trade-off between price stability and employment. Therefore, some level of inflation could be considered desirable to minimize unemployment. The Phillips curve model described the U.S. experience well in the 1960s but failed to describe the stagflation experienced in the 1970s. Thus, modern macroeconomics describes inflation using a Phillips curve that is able to shift due to such matters as supply shocks and structural inflation. The former refers to such events like the 1973 oil crisis, while the latter refers to the price/wage spiral and inflationary expectations implying that inflation is the new normal. Thus, the Phillips curve represents only the demand-pull component of the triangle model.

Another concept of note is the potential output (sometimes called the "natural gross domestic product"), a level of GDP, where the economy is at its optimal level of production given institutional and natural constraints. (This level of output corresponds to the Non-Accelerating Inflation Rate of Unemployment, NAIRU, or the "natural" rate of unemployment or the full-employment unemployment rate.) If GDP exceeds its potential (and unemployment is below the NAIRU), the theory says that inflation will accelerate as suppliers increase their prices and built-in inflation worsens. If GDP falls below its potential level (and unemployment is above the NAIRU), inflation will decelerate as suppliers attempt to fill excess capacity, cutting prices and undermining built-in inflation.[46]

However, one problem with this theory for policy-making purposes is that the exact level of potential output (and of the NAIRU) is generally unknown and tends to change over time. Inflation also seems to act in an asymmetric way, rising more quickly than it falls. Worse, it can change because of policy: for example, high unemployment under British Prime Minister Margaret Thatcher might have led to a rise in the NAIRU (and a fall in potential) because many of the unemployed found themselves as structurally unemployed, unable to find jobs that fit their skills. A rise in structural unemployment implies that a smaller percentage of the labor force can find jobs at the NAIRU, where the economy avoids crossing the threshold into the realm of accelerating inflation.

Unemployment

A connection between inflation and unemployment has been drawn since the emergence of large scale unemployment in the 19th century, and connections continue to be drawn today. However, the unemployment rate generally only affects inflation in the short-term but not the long-term.[47] In the long term, the velocity of money is far more predictive of inflation than low unemployment.[48]

In Marxian economics, the unemployed serve as a reserve army of labor, which restrain wage inflation. In the 20th century, similar concepts in Keynesian economics include the NAIRU (Non-Accelerating Inflation Rate of Unemployment) and the Phillips curve.

Monetarist view

M2andInflation
Inflation and the growth of money supply (M2)

Monetarists believe the most significant factor influencing inflation or deflation is how fast the money supply grows or shrinks. They consider fiscal policy, or government spending and taxation, as ineffective in controlling inflation.[49] The monetarist economist Milton Friedman famously stated, "Inflation is always and everywhere a monetary phenomenon."[50]

Monetarists assert that the empirical study of monetary history shows that inflation has always been a monetary phenomenon. The quantity theory of money, simply stated, says that any change in the amount of money in a system will change the price level. This theory begins with the equation of exchange:

where

is the nominal quantity of money;
is the velocity of money in final expenditures;
is the general price level;
is an index of the real value of final expenditures;

In this formula, the general price level is related to the level of real economic activity (Q), the quantity of money (M) and the velocity of money (V). The formula is an identity because the velocity of money (V) is defined to be the ratio of final nominal expenditure () to the quantity of money (M).

Monetarists assume that the velocity of money is unaffected by monetary policy (at least in the long run), and the real value of output is determined in the long run by the productive capacity of the economy. Under these assumptions, the primary driver of the change in the general price level is changes in the quantity of money. With exogenous velocity (that is, velocity being determined externally and not being influenced by monetary policy), the money supply determines the value of nominal output (which equals final expenditure) in the short run. In practice, velocity is not exogenous in the short run, and so the formula does not necessarily imply a stable short-run relationship between the money supply and nominal output. However, in the long run, changes in velocity are assumed to be determined by the evolution of the payments mechanism. If velocity is relatively unaffected by monetary policy, the long-run rate of increase in prices (the inflation rate) is equal to the long-run growth rate of the money supply plus the exogenous long-run rate of velocity growth minus the long run growth rate of real output.[11]

Effect of economic growth

If economic growth matches the growth of the money supply, inflation should not occur when all else is equal.[51] A large variety of factors can affect the rate of both. For example, investment in market production, infrastructure, education, and preventive health care can all grow an economy in greater amounts than the investment spending.[52][53]

Rational expectations theory

Rational expectations theory holds that economic actors look rationally into the future when trying to maximize their well-being, and do not respond solely to immediate opportunity costs and pressures. In this view, while generally grounded in monetarism, future expectations and strategies are important for inflation as well.

A core assertion of rational expectations theory is that actors will seek to "head off" central-bank decisions by acting in ways that fulfill predictions of higher inflation. This means that central banks must establish their credibility in fighting inflation, or economic actors will make bets that the central bank will expand the money supply rapidly enough to prevent recession, even at the expense of exacerbating inflation. Thus, if a central bank has a reputation as being "soft" on inflation, when it announces a new policy of fighting inflation with restrictive monetary growth economic agents will not believe that the policy will persist; their inflationary expectations will remain high, and so will inflation. On the other hand, if the central bank has a reputation of being "tough" on inflation, then such a policy announcement will be believed and inflationary expectations will come down rapidly, thus allowing inflation itself to come down rapidly with minimal economic disruption.

Austrian view

The Austrian School stresses that inflation is not uniform over all assets, goods, and services. Inflation depends on differences in markets and on where newly created money and credit enter the economy. Ludwig von Mises said that inflation should refer to an increase in the quantity of money that is not offset by a corresponding increase in the need for money, and that price inflation will necessarily follow.[54][55]

Real bills doctrine

The real bills doctrine asserts that banks should issue their money in exchange for short-term real bills of adequate value. As long as banks only issue a dollar in exchange for assets worth at least a dollar, the issuing bank's assets will naturally move in step with its issuance of money, and the money will hold its value. Should the bank fail to get or maintain assets of adequate value, then the bank's money will lose value, just as any financial security will lose value if its asset backing diminishes. The real bills doctrine (also known as the backing theory) thus asserts that inflation results when money outruns its issuer's assets. The quantity theory of money, in contrast, claims that inflation results when money outruns the economy's production of goods.

Currency and banking schools of economics argue the RBD, that banks should also be able to issue currency against bills of trading, which is "real bills" that they buy from merchants. This theory was important in the 19th century in debates between "Banking" and "Currency" schools of monetary soundness, and in the formation of the Federal Reserve. In the wake of the collapse of the international gold standard post 1913, and the move towards deficit financing of government, RBD has remained a minor topic, primarily of interest in limited contexts, such as currency boards. It is generally held in ill repute today, with Frederic Mishkin, a governor of the Federal Reserve going so far as to say it had been "completely discredited."

The debate between currency, or quantity theory, and the banking schools during the 19th century prefigures current questions about the credibility of money in the present. In the 19th century the banking schools had greater influence in policy in the United States and Great Britain, while the currency schools had more influence "on the continent", that is in non-British countries, particularly in the Latin Monetary Union and the earlier Scandinavia monetary union.

Effects

General

An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rise, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. For example, with inflation, those segments in society which own physical assets, such as property, stock etc., benefit from the price/value of their holdings going up, when those who seek to acquire them will need to pay more for them. Their ability to do so will depend on the degree to which their income is fixed. For example, increases in payments to workers and pensioners often lag behind inflation, and for some people income is fixed. Also, individuals or institutions with cash assets will experience a decline in the purchasing power of the cash. Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature.

Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The real interest on a loan is the nominal rate minus the inflation rate. The formula R = N-I approximates the correct answer as long as both the nominal interest rate and the inflation rate are small. The correct equation is r = n/i where r, n and i are expressed as ratios (e.g. 1.2 for +20%, 0.8 for −20%). As an example, when the inflation rate is 3%, a loan with a nominal interest rate of 5% would have a real interest rate of approximately 2% (in fact, it's 1.94%). Any unexpected increase in the inflation rate would decrease the real interest rate. Banks and other lenders adjust for this inflation risk either by including an inflation risk premium to fixed interest rate loans, or lending at an adjustable rate.

Negative

High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services to focus on profit and losses from currency inflation.[15] Uncertainty about the future purchasing power of money discourages investment and saving.[56] Inflation can also impose hidden tax increases. For instance, inflated earnings push taxpayers into higher income tax rates unless the tax brackets are indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such as some pensioners whose pensions are not indexed to the price level, towards those with variable incomes whose earnings may better keep pace with the inflation.[15] This redistribution of purchasing power will also occur between international trading partners. Where fixed exchange rates are imposed, higher inflation in one economy than another will cause the first economy's exports to become more expensive and affect the balance of trade. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.

Hoarding
People buy durable and/or non-perishable commodities and other goods as stores of wealth, to avoid the losses expected from the declining purchasing power of money, creating shortages of the hoarded goods.
Social unrest and revolts
Inflation can lead to massive demonstrations and revolutions. For example, inflation and in particular food inflation is considered as one of the main reasons that caused the 2010–11 Tunisian revolution[57] and the 2011 Egyptian revolution,[58] according to many observers including Robert Zoellick,[59] president of the World Bank. Tunisian president Zine El Abidine Ben Ali was ousted, Egyptian President Hosni Mubarak was also ousted after only 18 days of demonstrations, and protests soon spread in many countries of North Africa and Middle East.
Hyperinflation
If inflation becomes too high, it can cause people to severely curtail their use of the currency, leading to an acceleration in the inflation rate. High and accelerating inflation grossly interferes with the normal workings of the economy, hurting its ability to supply goods. Hyperinflation can lead to the abandonment of the use of the country's currency (for example as in North Korea) leading to the adoption of an external currency (dollarization).[60]
Allocative efficiency
A change in the supply or demand for a good will normally cause its relative price to change, signaling the buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, price changes due to genuine relative price signals are difficult to distinguish from price changes due to general inflation, so agents are slow to respond to them. The result is a loss of allocative efficiency.
Shoe leather cost
High inflation increases the opportunity cost of holding cash balances and can induce people to hold a greater portion of their assets in interest paying accounts. However, since cash is still needed to carry out transactions this means that more "trips to the bank" are necessary to make withdrawals, proverbially wearing out the "shoe leather" with each trip.
Menu costs
With high inflation, firms must change their prices often to keep up with economy-wide changes. But often changing prices is itself a costly activity whether explicitly, as with the need to print new menus, or implicitly, as with the extra time and effort needed to change prices constantly.

Positive

Labour-market adjustments
Nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and high unemployment in the labor market. Since inflation allows real wages to fall even if nominal wages are kept constant, moderate inflation enables labor markets to reach equilibrium faster.[61]
Room to maneuver
The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and open market operations, which are the central bank's interventions into the bonds market with the aim of affecting the nominal interest rate. If an economy finds itself in a recession with already low, or even zero, nominal interest rates, then the bank cannot cut these rates further (since negative nominal interest rates are impossible) to stimulate the economy – this situation is known as a liquidity trap.
Mundell–Tobin effect
The Nobel laureate Robert Mundell noted that moderate inflation would induce savers to substitute lending for some money holding as a means to finance future spending. That substitution would cause market clearing real interest rates to fall.[62] The lower real rate of interest would induce more borrowing to finance investment. In a similar vein, Nobel laureate James Tobin noted that such inflation would cause businesses to substitute investment in physical capital (plant, equipment, and inventories) for money balances in their asset portfolios. That substitution would mean choosing the making of investments with lower rates of real return. (The rates of return are lower because the investments with higher rates of return were already being made before.)[63] The two related effects are known as the Mundell–Tobin effect. Unless the economy is already overinvesting according to models of economic growth theory, that extra investment resulting from the effect would be seen as positive.
Instability with deflation
Economist S.C. Tsiang noted that once substantial deflation is expected, two important effects will appear; both a result of money holding substituting for lending as a vehicle for saving.[64] The first was that continually falling prices and the resulting incentive to hoard money will cause instability resulting from the likely increasing fear, while money hoards grow in value, that the value of those hoards are at risk, as people realize that a movement to trade those money hoards for real goods and assets will quickly drive those prices up. Any movement to spend those hoards "once started would become a tremendous avalanche, which could rampage for a long time before it would spend itself."[65] Thus, a regime of long-term deflation is likely to be interrupted by periodic spikes of rapid inflation and consequent real economic disruptions. Moderate and stable inflation would avoid such a seesawing of price movements.
Financial market inefficiency with deflation
The second effect noted by Tsiang is that when savers have substituted money holding for lending on financial markets, the role of those markets in channeling savings into investment is undermined. With nominal interest rates driven to zero, or near zero, from the competition with a high return money asset, there would be no price mechanism in whatever is left of those markets. With financial markets effectively euthanized, the remaining goods and physical asset prices would move in perverse directions. For example, an increased desire to save could not push interest rates further down (and thereby stimulate investment) but would instead cause additional money hoarding, driving consumer prices further down and making investment in consumer goods production thereby less attractive. Moderate inflation, once its expectation is incorporated into nominal interest rates, would give those interest rates room to go both up and down in response to shifting investment opportunities, or savers' preferences, and thus allow financial markets to function in a more normal fashion.

Controlling inflation

Federal Funds Rate (effective)
The U.S. effective federal funds rate charted over fifty years

Although both fiscal and monetary policy can affect inflation, ever since the 1980s, most countries primarily use monetary policy to control inflation. Central banks such as the U.S. Federal Reserve increase the interest rate and slow or stop the growth of the money supply. Some central banks have a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied.

In the 21st century, most economists favor a low and steady rate of inflation. In most countries, central banks or other monetary authorities are tasked with keeping their interbank lending rates at low stable levels, and the targeted inflation rate is about 2% to 3%. Central bankers target a low inflation rate because they believe that high inflation is economically costly because it would create uncertainty about differences in relative prices and about the inflation rate itself. A low positive inflation rate is targeted rather than a zero or negative one because the latter could cause or worsen recessions;[13] low (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy.[14]

Higher interest rates reduce the economy’s money supply because fewer people seek loans. When banks make loans, the loan proceeds are generally deposited in bank accounts that are part of the money supply. Therefore, when a person pays back a loan and no other loans are made to replace it, the amount of bank deposits and hence the money supply decrease. For example, in the early 1980s, when the federal funds rate exceeded 15 percent, the quantity of Federal Reserve dollars fell 8.1 percent, from US$8.6 trillion down to $7.9 trillion.

In the later part of the 20th century, there was a debate between Keynesians and monetarists about the appropriate instrument to use to control inflation. Monetarists emphasized a low and steady growth rate of the money supply. Keynesians emphasize reducing aggregate demand during economic expansions and increasing demand during recessions to keep inflation stable. Control of aggregate demand can be achieved using both monetary policy and fiscal policy (increased taxation or reduced government spending to reduce demand).

A variety of other methods and policies have been proposed and used to control inflation.

Fixed exchange rates

Under a fixed exchange rate currency regime, a country's currency is tied in value to another single currency or to a basket of other currencies (or sometimes to another measure of value, such as gold). A fixed exchange rate is usually used to stabilize the value of a currency, vis-a-vis the currency it is pegged to. It can also be used as a means to control inflation. However, as the value of the reference currency rises and falls, so does the currency pegged to it. This essentially means that the inflation rate in the fixed exchange rate country is determined by the inflation rate of the country the currency is pegged to. In addition, a fixed exchange rate prevents a government from using domestic monetary policy to achieve macroeconomic stability.

Under the Bretton Woods agreement, most countries around the world had currencies that were fixed to the U.S. dollar. This limited inflation in those countries, but also exposed them to the danger of speculative attacks. After the Bretton Woods agreement broke down in the early 1970s, countries gradually turned to floating exchange rates. However, in the later part of the 20th century, some countries reverted to a fixed exchange rate as part of an attempt to control inflation. This policy of using a fixed exchange rate to control inflation was used in many countries in South America in the later part of the 20th century (e.g. Argentina (1991–2002), Bolivia, Brazil, and Chile).

Gold standard

Two 20kr gold coins
Two 20 krona gold coins from the Scandinavian Monetary Union, a historical example of an international gold standard

The gold standard is a monetary system in which a region's common medium of exchange is paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The standard specifies how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself has no innate value, but is accepted by traders because it can be redeemed for the equivalent specie. A U.S. silver certificate, for example, could be redeemed for an actual piece of silver.

The gold standard was partially abandoned via the international adoption of the Bretton Woods system. Under this system all other major currencies were tied at fixed rates to the dollar, which itself was tied to gold at the rate of US$35 per ounce. The Bretton Woods system broke down in 1971, causing most countries to switch to fiat money – money backed only by the laws of the country.

Under a gold standard, the long term rate of inflation (or deflation) would be determined by the growth rate of the supply of gold relative to total output.[66] Critics argue that this will cause arbitrary fluctuations in the inflation rate, and that monetary policy would essentially be determined by gold mining.[67][68]

Wage and price controls

Another method attempted in the past have been wage and price controls ("incomes policies"). Wage and price controls have been successful in wartime environments in combination with rationing. However, their use in other contexts is far more mixed. Notable failures of their use include the 1972 imposition of wage and price controls by Richard Nixon. More successful examples include the Prices and Incomes Accord in Australia and the Wassenaar Agreement in the Netherlands.

In general, wage and price controls are regarded as a temporary and exceptional measure, only effective when coupled with policies designed to reduce the underlying causes of inflation during the wage and price control regime, for example, winning the war being fought. They often have perverse effects, due to the distorted signals they send to the market. Artificially low prices often cause rationing and shortages and discourage future investment, resulting in yet further shortages. The usual economic analysis is that any product or service that is under-priced is overconsumed. For example, if the official price of bread is too low, there will be too little bread at official prices, and too little investment in bread making by the market to satisfy future needs, thereby exacerbating the problem in the long term.

Temporary controls may complement a recession as a way to fight inflation: the controls make the recession more efficient as a way to fight inflation (reducing the need to increase unemployment), while the recession prevents the kinds of distortions that controls cause when demand is high. However, in general the advice of economists is not to impose price controls but to liberalize prices by assuming that the economy will adjust and abandon unprofitable economic activity. The lower activity will place fewer demands on whatever commodities were driving inflation, whether labor or resources, and inflation will fall with total economic output. This often produces a severe recession, as productive capacity is reallocated and is thus often very unpopular with the people whose livelihoods are destroyed (see creative destruction).

Cost-of-living allowance

The real purchasing power of fixed payments is eroded by inflation unless they are inflation-adjusted to keep their real values constant. In many countries, employment contracts, pension benefits, and government entitlements (such as social security) are tied to a cost-of-living index, typically to the consumer price index.[69] A cost-of-living adjustment (COLA) adjusts salaries based on changes in a cost-of-living index. It does not control inflation, but rather seeks to mitigate the consequences of inflation for those on fixed incomes. Salaries are typically adjusted annually in low inflation economies. During hyperinflation they are adjusted more often.[69] They may also be tied to a cost-of-living index that varies by geographic location if the employee moves.

Annual escalation clauses in employment contracts can specify retroactive or future percentage increases in worker pay which are not tied to any index. These negotiated increases in pay are colloquially referred to as cost-of-living adjustments ("COLAs") or cost-of-living increases because of their similarity to increases tied to externally determined indexes.[70]

See also

Notes

  1. ^ Wyplosz & Burda 1997 (Glossary)
  2. ^ Blanchard 2000 (Glossary)
  3. ^ Barro 1997 (Glossary)
  4. ^ Abel & Bernanke 1995 (Glossary)
  5. ^ Why price stability? Archived October 14, 2008, at the Wayback Machine, Central Bank of Iceland, Accessed on September 11, 2008.
  6. ^ Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429. "The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes that the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements."
  7. ^ Mankiw 2002, pp. 22–32
  8. ^ Mankiw 2002, pp. 238–255
  9. ^ Robert Barro and Vittorio Grilli (1994), European Macroeconomics, Ch. 8, p. 139, Fig. 8.1. Macmillan, ISBN 0-333-57764-7.
  10. ^ "MZM velocity". Retrieved September 13, 2014.
  11. ^ a b Mankiw 2002, pp. 81–107
  12. ^ Abel & Bernanke 2005, pp. 266–269
  13. ^ a b Hummel, Jeffrey Rogers. "Death and Taxes, Including Inflation: the Public versus Economists" (January 2007).[1] p. 56
  14. ^ a b "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others" Lars E.O. Svensson, Journal of Economic Perspectives, Volume 17, Issue 4 Fall 2003, pp. 145–166
  15. ^ a b c d Taylor, Timothy (2008). Principles of Economics. Freeload Press. ISBN 1-930789-05-X.
  16. ^ Dobson, Roger (January 27, 2002). "How Alexander caused a great Babylon inflation". The Independent. Archived from the original on April 12, 2010. Retrieved April 12, 2010.
  17. ^ Harl, Kenneth W. (June 19, 1996). "Coinage in the Roman Economy, 300 B.C. to A.D. 700". Baltimore: The Johns Hopkins University Press. ISBN 0-8018-5291-9.
  18. ^ "Annual Report (2006), Royal Canadian Mint, p. 4" (PDF). Mint.ca. Retrieved May 21, 2011.
  19. ^ Frank Shostak, "Commodity Prices and Inflation: What's the connection", Mises Institute
  20. ^ Richard von Glahn (December 27, 1996). Fountain of Fortune: Money and Monetary Policy in China, 1000–1700. University of California Press. p. 48. ISBN 978-0-520-20408-9.
  21. ^ Paul S. Ropp (July 9, 2010). China in World History. Oxford University Press. p. 82. ISBN 978-0-19-517073-3.
  22. ^ Peter Bernholz (2003). Monetary Regimes and Inflation: History, Economic and Political Relationships. Edward Elgar Publishing. pp. 53–55. ISBN 978-1-84376-155-6.
  23. ^ Earl J. Hamilton, American Treasure and the Price Revolution in Spain, 1501–1650 Harvard Economic Studies, 43 (Cambridge, Massachusetts: Harvard University Press, 1934)
  24. ^ John Munro: The Monetary Origins of the 'Price Revolution':South Germany Silver Mining, Merchant Banking, and Venetian Commerce, 1470–1540, Toronto 2003 Archived March 6, 2009, at the Wayback Machine
  25. ^ Walton, Timothy R. (1994). The Spanish Treasure Fleets. Pineapple Press (FL). p. 85. ISBN 1-56164-049-2.
  26. ^ The Price Revolution in Europe: Empirical Results from a Structural Vectorautoregression Model. Peter Kugler and Peter Bernholz, University of Basel, 2007 (Demonstrates that it was the increased supply of precious metals that caused it and notes the obvious logical flaws in the contrary arguments that have become fashionable in recent decades)
  27. ^ Tracy, James D. (1994). Handbook of European History 1400–1600: Late Middle Ages, Renaissance, and Reformation. Boston: Brill Academic Publishers. p. 655. ISBN 90-04-09762-7.
  28. ^ a b Bryan, Michael F. (October 15, 1997). "On the Origin and Evolution of the Word "Inflation"". Federal Reserve Bank of Cleveland, Economic Commentary.
  29. ^ Mark Blaug, "Economic Theory in Retrospect", pg. 129: "...this was the cause of inflation, or, to use the language of the day, 'the depreciation of banknotes.'"
  30. ^ Corina, Pons; Luc, Cohen; O'Brien, Rosalba (7 November 2018). "Venezuela's annual inflation hit 833,997 percent in October: Congress". Reuters. Retrieved 9 November 2018.
  31. ^ Baker, Gerard (2007-01-19). "Welcome to 'the Great Moderation'". The Times. London: Times Newspapers. ISSN 0140-0460. Retrieved 15 April 2011.
  32. ^ Bryan, Michael F., 1997. "On the Origin and Evolution of the Word Inflation," Federal Reserve Bank of Cleveland, Economic Commentary, 10.15.1997. https://www.clevelandfed.org/newsroom-and-events/publications/economic-commentary/economic-commentary-archives/1997-economic-commentaries/ec-19971015-on-the-origin-and-evolution-of-the-word-inflation.aspx
  33. ^ Federal Reserve Board's semiannual Monetary Policy Report to the Congress. Introductory statement by Jean-Claude Trichet on July 1, 2004
  34. ^ "What is inflation? – Inflation, explained – Vox". Vox. July 25, 2014. Retrieved September 13, 2014.
  35. ^ "University of Michigan: Inflation Expectation". Economic Research, Federal Reserve Bank of St. Louis.
  36. ^ Kiley, Michael J. (July 2008). Estimating the common trend rate of inflation for consumer prices and consumer prices excluding food and energy prices (PDF). Finance and Economic Discussion Series. Federal Reserve Board. Retrieved May 13, 2015.
  37. ^ See: The consumer price index measures movements in prices of a fixed basket of goods and services purchased by a "typical consumer".
  38. ^ The numbers reported here refer to the US Consumer Price Index for All Urban Consumers, All Items, series CPIAUCNS, from base level 100 in base year 1982. They were downloaded from the FRED database at the Federal Reserve Bank of St. Louis on August 8, 2008.
  39. ^ "Median Price Changes: An Alternative Approach to Measuring Current Monetary Inflation" (PDF). Archived from the original (PDF) on May 15, 2011. Retrieved May 21, 2011.
  40. ^ "IMF reprimands Argentina for inaccurate economic data". Retrieved February 2, 2013.
  41. ^ "Argentina Becomes First Nation Censured by IMF on Economic Data". Retrieved February 2, 2013.
  42. ^ Federal Reserve Board's semiannual Monetary Policy Report to the Congress Roundtable Archived September 30, 2007, at the Wayback Machine Introductory statement by Jean-Claude Trichet on July 1, 2004 Archived August 12, 2015, at the Wayback Machine
  43. ^ Robert J. Gordon (1988), Macroeconomics: Theory and Policy, 2nd ed., Chap. 22.4, 'Modern theories of inflation'. McGraw-Hill.
  44. ^ "Encyclopædia Britannica". Encyclopædia Britannica. Retrieved September 13, 2014.
  45. ^ O'Sullivan, Arthur; Sheffrin, Steven M. (2003) [January 2002]. Economics: Principles in Action. The Wall Street Journal:Classroom Edition (2nd ed.). Upper Saddle River, New Jersey 07458: Pearson Prentice Hall: Addison Wesley Longman. p. 341. ISBN 0-13-063085-3.
  46. ^ Coe, David T. "Nominal Wages. The NAIRU and Wage Flexibility" (PDF). Organisation for Economic Co-operation and Development.
  47. ^ Chang, R. (1997) "Is Low Unemployment Inflationary?" Archived November 13, 2013, at the Wayback Machine Federal Reserve Bank of Atlanta Economic Review 1Q97:4–13
  48. ^ Oliver Hossfeld (2010) "US Money Demand, Monetary Overhang, and Inflation Prediction" International Network for Economic Research working paper no. 2010.4
  49. ^ Lagassé, Paul (2000). "Monetarism". The Columbia Encyclopedia (6th ed.). New York: Columbia University Press. ISBN 0-7876-5015-3.
  50. ^ Friedman, Milton; Schwartz, Anna Jacobson (1963). A Monetary History of the United States, 1867–1960. Princeton University Press.
  51. ^ Sigrauski, Miguel (1961). "Inflation and Economic Growth". Journal of Political Economy. 75 (6): 796–810. CiteSeerX 10.1.1.330.9556. doi:10.1086/259360.
  52. ^ Henderson, David R. (1999). "Does Growth Cause Inflation?". Cato Policy Report. 21.
  53. ^ "In Investing, It's When You Start And When You Finish". New York Times. January 2, 2012.
  54. ^ Von Mises, Ludwig (1912). The Theory of Money and Credit (PDF) (1953 ed.). Yale University Press. p. 240. Retrieved January 23, 2014. In theoretical investigation there is only one meaning that can rationally be attached to the expression Inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange-value of money must occur.
  55. ^ The Theory of Money and Credit, Mises (1912, [1981], p. 272)
  56. ^ Bulkley, George (March 1981). "Personal Savings and Anticipated Inflation". The Economic Journal. 91 (361): 124–135. doi:10.2307/2231702. JSTOR 2231702.
  57. ^ "Les Egyptiens souffrent aussi de l'accélération de l'inflation", Céline Jeancourt-Galignani – La Tribune, February 10, 2011
  58. ^ AFP (January 27, 2011). "Egypt protests a ticking time bomb: Analysts". The New Age. Archived from the original on February 9, 2011. Retrieved January 29, 2011.
  59. ^ "Les prix alimentaires proches de "la cote d'alerte"" – Le Figaro, with AFP, February 20, 2011
  60. ^ Steve H. Hanke (July 2013). "North Korea: From Hyperinflation to Dollarization?". Retrieved August 21, 2014.
  61. ^ Tobin, James, American Economic Review, march (1969), "Inflation and Unemployment"
  62. ^ Mundell, James (1963). "Inflation and Real Interest". Journal of Political Economy. LXXI: 280–83. doi:10.1086/258771.
  63. ^ Tobin, J. Econometrica, Vol. 33, (1965), pp. 671–84 "Money and Economic Growth"
  64. ^ Tsiang, S.C., Journal of Money, Credit and Banking, I(1969), pp. 266–80 "A Critical Note on the Optimum Supply of Money"
  65. ^ Tsiang, 1969 (p272)
  66. ^ Bordo, Michael D. (2002). "Gold Standard". The Concise Encyclopedia of Economics. Library of Economics and Liberty.
  67. ^ Barsky, Robert B; DeLong, J Bradford (1991). "Forecasting Pre-World War I Inflation: The Fisher Effect and the Gold Standard". Quarterly Journal of Economics. 106 (3): 815–36. doi:10.2307/2937928. JSTOR 2937928. Retrieved September 27, 2008.
  68. ^ DeLong, Brad. "Why Not the Gold Standard?". Retrieved September 25, 2008.
  69. ^ a b Flanagan, Tammy (September 8, 2006). "COLA Wars". Government Executive. National Journal Group. Retrieved September 23, 2008.
  70. ^ SueKunkel. "Cost-Of-Living Adjustment (COLA)". www.ssa.gov. Retrieved 2018-05-15.

References

  • Abel, Andrew; Bernanke, Ben (2005). "Macroeconomics" (5th ed.). Pearson. Measurement of inflation is discussed in Ch. 2, pp. 45–50; Money growth & Inflation in Ch. 7, pp. 266–269; Keynesian business cycles and inflation in Ch. 9, pp. 308–348.
  • Barro, Robert J. (1997). Macroeconomics. Cambridge, Massachusetts: MIT Press. p. 895. ISBN 0-262-02436-5.
  • Blanchard, Olivier (2000). Macroeconomics (2nd ed.). Englewood Cliffs, N.J: Prentice Hall. ISBN 0-13-013306-X.
  • Mankiw, N. Gregory (2002). "Macroeconomics" (5th ed.). Worth. Measurement of inflation is discussed in Ch. 2, pp. 22–32; Money growth & Inflation in Ch. 4, pp. 81–107; Keynesian business cycles and inflation in Ch. 9, pp. 238–255.
  • Hall, Robert E.; Taylor, John B. (1993). Macroeconomics. New York: W.W. Norton. p. 637. ISBN 0-393-96307-1.
  • Burda, Michael C.; Wyplosz, Charles (1997). Macroeconomics: a European text. Oxford [Oxfordshire]: Oxford University Press. ISBN 0-19-877468-0.

Further reading

External links

Consumer price index

A Consumer Price Index measures changes in the price level of market basket of consumer goods and services purchased by households.

The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. Sub-indices and sub-sub-indices are computed for different categories and sub-categories of goods and services, being combined to produce the overall index with weights reflecting their shares in the total of the consumer expenditures covered by the index. It is one of several price indices calculated by most national statistical agencies. The annual percentage change in a CPI is used as a measure of inflation. A CPI can be used to index (i.e. adjust for the effect of inflation) the real value of wages, salaries, and pensions; to regulate prices; and to deflate monetary magnitudes to show changes in real values. In most countries, the CPI, along with the population census, is one of the most closely watched national economic statistics.

The index is usually computed monthly, or quarterly in some countries, as a weighted average of sub-indices for different components of consumer expenditure, such as food, housing, shoes, clothing, each of which is in turn a weighted average of sub-sub-indices. At the most detailed level, the elementary aggregate level, (for example, men's shirts sold in department stores in San Francisco), detailed weighting information is unavailable, so indices are computed using an unweighted arithmetic or geometric mean of the prices of the sampled product offers. (However, the growing use of scanner data is gradually making weighting information available even at the most detailed level.) These indices compare prices each month with prices in the price-reference month. The weights used to combine them into the higher-level aggregates, and then into the overall index, relate to the estimated expenditures during a preceding whole year of the consumers covered by the index on the products within its scope in the area covered. Thus the index is a fixed-weight index, but rarely a true Laspeyres index, since the weight-reference period of a year and the price-reference period, usually a more recent single month, do not coincide.

Ideally, the weights would relate to the composition of expenditure during the time between the price-reference month and the current month. There is a large technical economics literature on index formulas which would approximate this and which can be shown to approximate what economic theorists call a true cost-of-living index. Such an index would show how consumer expenditure would have to move to compensate for price changes so as to allow consumers to maintain a constant standard of living. Approximations can only be computed retrospectively, whereas the index has to appear monthly and, preferably, quite soon. Nevertheless, in some countries, notably in the United States and Sweden, the philosophy of the index is that it is inspired by and approximates the notion of a true cost of living (constant utility) index, whereas in most of Europe it is regarded more pragmatically.

The coverage of the index may be limited. Consumers' expenditure abroad is usually excluded; visitors' expenditure within the country may be excluded in principle if not in practice; the rural population may or may not be included; certain groups such as the very rich or the very poor may be excluded. Saving and investment are always excluded, though the prices paid for financial services provided by financial intermediaries may be included along with insurance.

The index reference period, usually called the base year, often differs both from the weight-reference period and the price-reference period. This is just a matter of rescaling the whole time-series to make the value for the index reference-period equal to 100. Annually revised weights are a desirable but expensive feature of an index, for the older the weights the greater is the divergence between the current expenditure pattern and that of the weight reference-period.

Deflation

In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the value of currency over time, but deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e. when inflation declines to a lower rate but is still positive.Economists generally believe that deflation is a problem in a modern economy because it increases the real value of debt, especially if the deflation is unexpected. Deflation may also aggravate recessions and lead to a deflationary spiral.Deflation usually happens when supply is high (when excess production occurs), when demand is low (when consumption decreases), or when the money supply decreases (sometimes in response to a contraction created from careless investment or a credit crunch). It can also occur due to too much competition and too little market concentration.

Full employment

Full employment is a situation in which everyone who wants a job can have work hours they need on "fair wages". Because people switch jobs, full employment involves a positive stable rate of unemployment. An economy with full employment might still have underemployment where part-time workers cannot find jobs appropriate to their skill level. In macroeconomics, full employment is sometimes defined as the level of employment at which there is no cyclical or deficient-demand unemployment.Some economists reject policies that target full employment and see inflation as being a likely consequence of such targeting. Advocacy of avoiding accelerating inflation is based on a theory centered on the concept of the Non-Accelerating Inflation Rate of Unemployment (NAIRU), and those who hold it usually mean NAIRU when speaking of full employment. The NAIRU has also been described by Milton Friedman, among others, as the "natural" rate of unemployment.

For the United States, economist William T. Dickens found that full-employment unemployment rate varied a lot over time but equaled about 5.5 percent of the civilian labor force during the 2000s. Recently, economists have emphasized the idea that full employment represents a "range" of possible unemployment rates. For example, in 1999, in the United States, the Organisation for Economic Co-operation and Development (OECD) gives an estimate of the "full-employment unemployment rate" of 4 to 6.4%. This is the estimated unemployment rate at full employment, plus & minus the standard error of the estimate.The concept of full employment of labor corresponds to the concept of potential output or potential real GDP and the long run aggregate supply (LRAS) curve. In neoclassical macroeconomics, the highest sustainable level of aggregate real GDP or "potential" is seen as corresponding to a vertical LRAS curve: any increase in the demand for real GDP can only lead to rising prices in the long run, while any increase in output is temporary.

Hyperinflation

In economics, hyperinflation is very high and typically accelerating inflation. It quickly erodes the real value of the local currency, as the prices of all goods increase. This causes people to minimize their holdings in that currency as they usually switch to more stable foreign currencies, often the US Dollar. Prices typically remain stable in terms of other relatively stable currencies.

Unlike low inflation, where the process of rising prices is protracted and not generally noticeable except by studying past market prices, hyperinflation sees a rapid and continuing increase in nominal prices, the nominal cost of goods, and in the supply of money. Typically, however, the general price level rises even more rapidly than the money supply as people try ridding themselves of the devaluing currency as quickly as possible. As this happens, the real stock of money (i.e., the amount of circulating money divided by the price level) decreases considerably.Hyperinflation is often associated with some stress to the government budget, such as wars or their aftermath, sociopolitical upheavals, a collapse in aggregate supply or one in export prices, or other crises that make it difficult for the government to collect tax revenue. A sharp decrease in real tax revenue coupled with a strong need to maintain government spending, together with an inability or unwillingness to borrow, can lead a country into hyperinflation.

Hyperinflation in the Weimar Republic

Hyperinflation affected the German Papiermark, the currency of the Weimar Republic, between 1921 and 1923. It caused considerable internal political instability in the country, the occupation of the Ruhr by France and Belgium as well as misery for the general populace.

Inflation (cosmology)

In physical cosmology, cosmic inflation, cosmological inflation, or just inflation, is a theory of exponential expansion of space in the early universe. The inflationary epoch lasted from 10−36 seconds after the conjectured Big Bang singularity to some time between 10−33 and 10−32 seconds after the singularity. Following the inflationary period, the universe continues to expand, but at a less rapid rate.Inflation theory was first developed in 1979 by theoretical physicist Alan Guth at Cornell University. It was developed further in the early 1980s. It explains the origin of the large-scale structure of the cosmos. Quantum fluctuations in the microscopic inflationary region, magnified to cosmic size, become the seeds for the growth of structure in the Universe (see galaxy formation and evolution and structure formation). Many physicists also believe that inflation explains why the universe appears to be the same in all directions (isotropic), why the cosmic microwave background radiation is distributed evenly, why the universe is flat, and why no magnetic monopoles have been observed.

The detailed particle physics mechanism responsible for inflation is unknown. The basic inflationary paradigm is accepted by most physicists, as a number of inflation model predictions have been confirmed by observation; however, a substantial minority of scientists dissent from this position. The hypothetical field thought to be responsible for inflation is called the inflaton.In 2002, three of the original architects of the theory were recognized for their major contributions; physicists Alan Guth of M.I.T., Andrei Linde of Stanford, and Paul Steinhardt of Princeton shared the prestigious Dirac Prize "for development of the concept of inflation in cosmology". In 2012, Alan Guth and Andrei Linde were awarded the Breakthrough Prize in Fundamental Physics for their invention and development of inflationary cosmology.

Interest rate

An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, the compounding frequency, and the length of time over which it is lent, deposited or borrowed.

It is defined as the proportion of an amount loaned which a lender charges as interest to the borrower, normally expressed as an annual percentage. It is the rate a bank or other lender charges to borrow its money, or the rate a bank pays its savers for keeping money in an account.The annual interest rate is the rate over a period of one year. Other interest rates apply over different periods, such as a month or a day, but they are usually annualised.

List of highest-grossing Indian films

This is a ranking of the highest grossing Indian films which includes films from various languages based on the conservative global box office estimates as reported by reputable sources. There is no official tracking of domestic box office figures within India, and Indian sites publishing data are frequently pressured to increase their domestic box office estimates.Indian films have been screened in markets around the world since the early 20th century. As of 2003, there are markets in over 90 countries where films from India are screened. During the first decade of the 21st century, there was a steady rise in the ticket price, a tripling in the number of theaters and an increase in the number of prints of a film being released, which led to a large increase in the box office collections.The majority of highest-grossing Indian films are Bollywood (Hindi) films. As of 2014, Bollywood represents 43% of the net box office revenue in India, while Tamil and Telugu cinema represent 36%, and other regional industries constitute 21%. See List of highest-grossing films in India for domestic gross figures and List of highest-grossing Indian films in overseas markets for overseas gross figures.

List of highest-grossing films

Films generate income from several revenue streams, including theatrical exhibition, home video, television broadcast rights and merchandising. However, theatrical box office earnings are the primary metric for trade publications in assessing the success of a film, mostly because of the availability of the data compared to sales figures for home video and broadcast rights, but also because of historical practice. Included on the list are charts of the top box office earners (ranked by both the nominal and real value of their revenue), a chart of high-grossing films by calendar year, a timeline showing the transition of the highest-grossing film record, and a chart of the highest-grossing film franchises and series. All charts are ranked by international theatrical box office performance where possible, excluding income derived from home video, broadcasting rights and merchandise.

Traditionally, war films, musicals and historical dramas have been the most popular genres, but franchise films have been among the best performers in the 21st century. There is strong interest in the superhero genre, with eight films in the Marvel Cinematic Universe featuring among the nominal top-earners, including four films based on the Avengers comic books charting in the top ten. Other Marvel Comics adaptations have also had success with the Spider-Man and X-Men properties, while films based on Aquaman, Batman and Superman from DC Comics have generally performed well. Star Wars, Harry Potter and Peter Jackson's Middle-earth series are also represented in the nominal earnings chart with four films apiece, while the Jurassic Park and Pirates of the Caribbean franchises feature prominently. Although the nominal earnings chart is dominated by films adapted from pre-existing properties and sequels, it is headed by Avatar, which is an original work. Animated family films have performed consistently well, with Disney films enjoying lucrative re-releases prior to the home-video era. Disney also enjoyed later success with films such as Frozen (the highest-grossing animated film), Zootopia and The Lion King, as well as its Pixar filmography, of which Incredibles 2, Toy Story 3, and the Finding Nemo films have been the best performers. Beyond Disney and Pixar animation, the Despicable Me, Shrek and Ice Age series have met with the most success.

While inflation has eroded away the achievements of most films from the 1960s and 1970s, there are franchises originating from that period that are still active. Besides the Star Wars and Superman franchises, James Bond and Star Trek films are still being released periodically; all four are among the highest-grossing franchises. Some of the older films that held the record of highest-grossing film still have respectable grosses by today's standards, but no longer compete numerically against today's top-earners in an era of much higher individual ticket prices. When properly adjusted for inflation, however, on that comparative scale Gone with the Wind—which was the highest-grossing film outright for twenty-five years—is still the highest-grossing film of all time. All grosses on the list are expressed in U.S. dollars at their nominal value, except where stated otherwise.

List of highest-grossing films in the United States and Canada

The following is a list of the highest-grossing films in the United States and Canada, a market known in the film industry as the North American box office and the domestic box office, and where "gross" is defined in US dollars.

List of most expensive films

Due to the secretive nature of Hollywood accounting it is not clear which film is the most expensive film ever made. Pirates of the Caribbean: On Stranger Tides officially holds the record with a budget of $378.5 million, while The Hobbit trilogy stands as the most expensive back-to-back film production with combined costs of $623 million after tax credits.

Inflation, filming techniques and external market forces affect the economics of film production. Costs rose steadily during the silent era with Ben-Hur: A Tale of the Christ (1925) setting a record that lasted well into the sound era. Television had an impact on rising costs in the 1950s and early 1960s as cinema competed with it for audiences, culminating in 1963 with Cleopatra; despite being the highest earning film of the year, Cleopatra did not earn back its costs on its original release. The 1990s saw two thresholds crossed, with True Lies costing $100 million in 1994 and Titanic costing $200 million in 1997, both directed by James Cameron. Since then it has become normal for a tent-pole feature from a major film studio to cost over $100 million and an increasing number of films are costing $200 million or more.

This list contains only the films that are already released to the general public and no films that are still in production, post-production or just announced films, for the reason that these costs can change during the production process. Listed below is the net negative cost: the costs of the actual filming, not including promotional costs (i.e. advertisements, commercials, posters, etc.) and after accounting for tax subsidies. The charts are ordered by budgets officially acknowledged by the production companies where they are known; most companies will not give a statement on the actual production costs, only estimates by professional researchers and movie industry writers are available. Where budget estimates conflict, the productions are charted by lower-bound estimates.

Macroeconomics

Macroeconomics (from the Greek prefix makro- meaning "large" + economics) is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study aggregated indicators such as GDP, unemployment rates, national income, price indices, and the interrelations among the different sectors of the economy to better understand how the whole economy functions. They also develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, saving, investment, international trade, and international finance.

While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income). Macroeconomic models and their forecasts are used by governments to assist in the development and evaluation of economic policy.

Macroeconomics and microeconomics, a pair of terms coined by Ragnar Frisch, are the two most general fields in economics. In contrast to macroeconomics, microeconomics is the branch of economics that studies the behavior of individuals and firms in making decisions and the interactions among these individuals and firms in narrowly-defined markets.

Monetary policy

Monetary policy is the process by which the monetary authority of a country, typically the central bank or currency board, controls either the cost of very short-term borrowing or the money supply, often targeting inflation rate or interest rate to ensure price stability and general trust in the currency.Further goals of a monetary policy are usually to contribute to the stability of gross domestic product, to achieve and maintain low unemployment, and to maintain predictable exchange rates with other currencies.

Monetary economics provides insight into how to craft an optimal monetary policy. In developed countries, monetary policy has been generally formed separately from fiscal policy, which refers to taxation, government spending, and associated borrowing.Monetary policy is referred to as being either expansionary or contractionary. Expansionary policy occurs when a monetary authority uses its tools to stimulate the economy. An expansionary policy maintains short-term interest rates at a lower than usual rate or increases the total supply of money in the economy more rapidly than usual. It is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that less expensive credit will entice businesses into expanding. This increases aggregate demand (the overall demand for all goods and services in an economy), which boosts short-term growth as measured by gross domestic product (GDP) growth. Expansionary monetary policy usually diminishes the value of the currency relative to other currencies (the exchange rate).The opposite of expansionary monetary policy is contractionary monetary policy, which maintains short-term interest rates higher than usual or which slows the rate of growth in the money supply or even shrinks it. This slows short-term economic growth and lessens inflation. Contractionary monetary policy can lead to increased unemployment and depressed borrowing and spending by consumers and businesses, which can eventually result in an economic recession if implemented too vigorously.

Money supply

In economics, the money supply (or money stock) is the total value of monetary assets available in an economy at a specific time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits (depositors' easily accessed assets on the books of financial institutions).Money supply data are recorded and published, usually by the government or the central bank of the country. Public and private sector analysts have long monitored changes in the money supply because of the belief that it affects the price level, inflation, the exchange rate and the business cycle.That relation between money and prices is historically associated with the quantity theory of money. There is strong empirical evidence of a direct relation between money-supply growth and long-term price inflation, at least for rapid increases in the amount of money in the economy. For example, a country such as Zimbabwe which saw extremely rapid increases in its money supply also saw extremely rapid increases in prices (hyperinflation). This is one reason for the reliance on monetary policy as a means of controlling inflation.The nature of this causal chain is the subject of contention. Some heterodox economists argue that the money supply is endogenous (determined by the workings of the economy, not by the central bank) and that the sources of inflation must be found in the distributional structure of the economy.In addition, those economists seeing the central bank's control over the money supply as feeble say that there are two weak links between the growth of the money supply and the inflation rate. First, in the aftermath of a recession, when many resources are underutilized, an increase in the money supply can cause a sustained increase in real production instead of inflation. Second, if the velocity of money (i.e., the ratio between nominal GDP and money supply) changes, an increase in the money supply could have either no effect, an exaggerated effect, or an unpredictable effect on the growth of nominal GDP.

Phillips curve

The Phillips curve is a single-equation economic model, named after William

Phillips, describing an inverse relationship between rates of unemployment and corresponding rates of rises in wages that result within an economy. Stated simply, decreased unemployment, (i.e., increased levels of employment) in an economy will correlate with higher rates of wage rises. Phillips did not himself state there was any relationship between employment and inflation; this notion was a trivial deduction from his statistical findings. Samuelson and Solow made the connection explicit and subsequently Milton Friedman

and Edmund Phelps

put the theoretical structure in place. In so doing, Friedman was to successfully predict the imminent collapse of Phillips' a-theoretic correlation.

While there is a short run tradeoff between unemployment and inflation, it has not been observed in the long run. In 1967 and 1968, Milton Friedman and Edmund Phelps asserted that the Phillips curve was only applicable in the short-run and that in the long-run, inflationary policies would not decrease unemployment.

Friedman then correctly predicted that in the 1973–75 recession, both inflation and unemployment would increase. The long-run Phillips curve is now seen as a vertical line at the natural rate of unemployment, where the rate of inflation has no effect on unemployment. In the 2010s the slope of the Phillips curve appears to have declined and there has been controversy over the usefulness of the Phillips curve in predicting inflation. Nonetheless, the Phillips curve remains the primary framework for understanding and forecasting inflation used in central banks.

Real versus nominal value (economics)

In economics, a real value, of a good or other entity, is one which has been adjusted for inflation, enabling comparison of quantities as if prices had not changed (or prices had not changed on average). Changes in real terms therefore exclude the effect of inflation. In contrast with a real value, a nominal value has not been adjusted for inflation, and so changes in nominal value reflect at least in part the effect of inflation.

Retail price index

In the United Kingdom, the retail prices index or retail price index (RPI) is a measure of inflation published monthly by the Office for National Statistics. It measures the change in the cost of a representative sample of retail goods and services.

As the RPI was held not to meet international statistical standards, since 2013 the Office for National Statistics no longer classifies it as a "national statistic", emphasising the consumer price index instead.

However, as of 2018 the UK Treasury still uses the RPI measure of inflation for various index linked tax rises.

Stagflation

In economics, stagflation, or recession-inflation, is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment, and vice versa.

The term, a portmanteau of stagnation and inflation, is generally attributed to Iain Macleod, a British Conservative Party politician who became Chancellor of the Exchequer in 1970. Macleod used the word in a 1965 speech to Parliament during a period of simultaneously high inflation and unemployment in the United Kingdom.

Warning the House of Commons of the gravity of the situation, he said: "We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of "stagflation" situation. And history, in modern terms, is indeed being made."Macleod used the term again on 7 July 1970, and the media began also to use it, for example in The Economist on 15 August 1970, and Newsweek on 19 March 1973.

John Maynard Keynes did not use the term, but some of his work refers to the conditions that most would recognise as stagflation. In the version of Keynesian macroeconomic theory that was dominant between the end of World War II and the late 1970s, inflation and recession were regarded as mutually exclusive, the relationship between the two being described by the Phillips curve. Stagflation is very costly and difficult to eradicate once it starts, both in social terms and in budget deficits.

United States Treasury security

A United States Treasury security is a government debt instrument issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Treasury securities are often referred to simply as Treasuries. Since 2012 the management of government debt has been arranged by the Bureau of the Fiscal Service, succeeding the Bureau of the Public Debt.

There are four types of marketable treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS). The government sells these securities in auctions conducted by the Federal Reserve Bank of New York, and they trade heavily in secondary markets. Non-marketable securities include Savings Bonds, issued to the public and transferable only as gifts; the State and Local Government Series (SLGS), purchaseable only with the proceeds of state and municipal bond sales; and the Government Account Series, purchased by units of the federal government.

Treasury securities are backed by the full faith and credit of the United States, meaning that the government has promised to raise money from any available source to repay them. Although the United States is a sovereign power and may default on its debt, its strong record of repayment has given Treasury securities a reputation as one of the world's lowest-risk investments.

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