Inflation

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Inflation
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Inflation is bad news!

• Inflation will destroy the strongest of economies
• Problem we face as a nation
• Has damaging effects- government watches for signs

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• Inflation is an increase in the average price
  level for goods and services across an economy

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• Lets say the price of tires is rising rapidly
• Perhaps there is a rubber shortage causing the
  increase, or maybe people are simply buying a lot
  of radials
• Both of these situations can cause a price
  increase

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• A rise in the cost of one product is not a
  problem for the United States as a whole
• But what if the price of tires, groceries, toys,
  wood, cars, steel, and everything else for that
  matter, were on the rise?

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• Families would have a harder time living within
  their budget
• Even worse, companies would have a difficult time
  planning for their future

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• No one could predict next years prices
• Consumers would get nervous, and corporations
  would stop hiring and buying equipment

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• People tend to spend their money more vigorously
  in an inflationary economy, because they are
  afraid their money will lose value

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• In the late 1970s, annual prices were increasing
  at a rate of 13 per year
• That means that a car that cost 10,000 this year
  will cost 11,300 next year

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• A 100 grocery order will increase by another
  13.
• Because bank interest rates take time to keep up
  with such devaluation of the dollar, saving
  becomes less and less common for the consumer

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• People simply want to spend before their money
  loses any more value, especially for big ticket
  items like cars and appliances

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• This rapid spending prompts retailers to continue
  to raise prices in the face of the consumer frenzy

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• All in all, inflation creates more inflation
• People realize that prices are increasing and
  respond by spending their money more quickly

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• Inflation should be nipped in the bud
• If it is seen that the Consumer Price Index (CPI)
  and other indicators rose from 1.5 to 1.8 they
  would take measures to stop the trend

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• Inflation breeds more inflation
• Once it gets started, it is most difficult to
  stop it

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• http//inflationdata.com/inflation/Consumer_Price_
  Index/HistoricalCPI.aspx
• Consumer Price Index information

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• National rate of inflation has been around 1.5 to
  3 each year
• Bureau of Labor Statistics publishes two figures
  every month that are closely watched

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• Consumer Price Index (CPI) sample of 80,000 of
  the most commonly bought consumer goods from
  rental housing, utilities, food, clothes,
  entertainment, and health care

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• Total is compared to a base year (currently 1984)
  and a number of figures are calculated for
  various regions around the country (had been 1982)

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• Producer Price Index (PPI)- measures the
  different prices of goods at all stages of the
  production process
• Figures are compared to a base year- tally of
  products is kept

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• Worker has to earn more money to keep up the
  standard of living that he or she had last year
• Inflation will cause a rise in the price of most
  goods and services

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• It will simply cost more to run a household
• Professions have to keep up with inflation by
  offering workers cost of living increases

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• Many labor contracts and government programs like
  social security are directly ties to cost of
  living adjustment figures provided by the CPI

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• When prices reach a high enough point, consumers,
  tired of their wages not keeping up with the
  rising prices, may decide to stop buying all
  together to wait out the storm

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• The result will be a severe slowdown of the
  economy
• Lack of sales will force factories to shut their
  doors and existing companies to curtail production

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• Jobs will soon be lost
• Potential result of even a minor bout with
  inflation is a serious and prolonged depression
  where the consumer is too afraid to spend any
  money

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• Inflation has two ways of getting started
• It can come from the supply or our economy or the
  demand

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Supply Side Inflation

• Resource prices in our economy go up for various
  reasons
• These increased prices can force up the cost of
  other consumer and producer goods

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• In the Mid 1970s, OPEC countries imposed an
  embargo on the United States
• Price of a barrel more than doubled forcing the
  prices of every product in our country

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Demand Side Inflation

• People buying too many goods
• In essence, there are too many dollars chasing
  too few goods
• Our producers cannot keep up with consumer
  demand, and they raise the prices

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• But how do we keep people from buying things?
• And wasnt a hot economy a good thing?

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• Government watches how much people are buying
  (called aggregate demand) and how much factories
  are producing (called aggregate supply)

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• It has been mentioned that once inflation starts,
  it is very difficult to stop
• One major cause of this is due to a situation
  called the wage price spiral

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• When prices begin to rise, workers will begin to
  demand higher wages
• Suppliers can do this only if demand is strong
  enough to allow them to do so

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• If workers eventually get the extra money, they
  will tend to spend that quickly if they believe
  that prices will continue to rise

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• Store owners will notice the increased sales or
  the higher labor costs and then raise prices even
  more
• This is why it is vital to catch inflation before
  it starts

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• If inflation is left unchecked, people will
  eventually be unable to afford any products
• Banks will raise interest rates higher to ensure
  profits

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• With inflation of 13 in 1980, banks offered
  rates on home mortgages of almost 20
• This brought the construction and car industries
  to their knees

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• Nobody like the prospect of paying the interest
  that came with an inflationary economy

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• Worst case scenario comes when the government
  ignores the warning signs like a rising CPI and
  product shortages

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• If inflation is left completely unchecked and the
  money supply continues to grow too quickly prices
  can rise most rapidly

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• Germany in the 1920s printed billions of marks
  to pay back other countries for the reparations
  demanded in the Versailles Treaty

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• Markets responded to the flood of cheap money by
  jacking up prices to unbelievable heights

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• Imagine that this week when you buy a loaf of
  bread, it costs 1.00
• When you go shopping next week, you are amazed to
  find that the price has risen to 50.00

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• People had to carry baskets full of money just to
  buy their daily bread
• Hyperinflation eroded the confidence the German
  people had in their government

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• Their society had to deal with the chaos. This
  is one of the reasons that Hitler rose to power

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• Deflation is a condition where the average prices
  for goods and services falls across the economy

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• In the late 1800s, farmers who were already hit
  hard by plummeting prices due to automation, also
  had to deal with the gold backed currency that
  steadily increased in value

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• (because the growth of the money supply did not
  keep up with the growth of the economy)

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• Their crop prices fell even further
• When they needed to borrow money to save their
  farms, banks- noticing the scarcity of money-
  raised interest rates as high as 80

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• Today, for many reasons, we prefer a controlled
  amount of inflation around 1 to 3
• Dont confuse deflation with a situation called
  disinflation

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Disinflation

• Rate of inflation falls from a higher rate to a
  lower rate without becoming deflationary
• When inflation rates fell from 13 in 1980 to 4
  in 1985, it was said that the dollar was
  disinflating

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• What if the unemployment that usually comes with
  a severe period of inflation continues for a
  prolonged period of time?

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• We are stuck with high inflation and high
  unemployment called stagflation
• It is difficult to envision a worse scenario

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• In the early 1970s, spending on the Vietnam War
  and social programs were financed with an
  increase in the money supply

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• When oil prices shot up from 1 a barrel in 1970
  to 35 a barrel in 1982, prices shot up further
  and businesses cut back production because
  resource prices were cutting into profits

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Inflation Questions

• 1. If the CPI was 100 in 1983, and a leather
  couch cost 650 at that time, how much would that
  couch cost today with the CPI at 165 if the price
  of the couch increased at the same rate as the
  inflation rate?

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• 2. If the CPI was 155.2 in 1995 and 149.9 in
  1994, what was the rate of inflation (in
  percentage terms) for 1994-1995?

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• 3. If inflation is so bad, list four of the
  negative impacts