Transcript 04.2_Deflation - econbus

Inflation & Deflation
Recap & move forward…
1
Recap
• What was the more recent ‘FIVE’ causes
of UK’s rise in inflation last month?
2
Recap
• What was the more recent ‘FIVE’ causes
of UK’s rise in inflation last month?
• F= Fuel
• I = Imports create higher costs
• V = VAT
• E= exchange rates
3
Recap
• In theory – what are the 2 different types
of inflation?
–Demand pull inflation
–Cost push inflation
4
Recap
• Can you draw me a demand pull inflation
diagram (show SR & LR AS)
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DEMAND PULL INFLATION
SRAS2
LRAS
Price Level
SRAS
AD1
In the LR, workers
are not willing to
sacrifice Leisure
time for more
overtime…. But
still have high
wage
expectations….
demand pull
inflation
AD
0
Y1
Y2
Real National
Output
6
Recap
• Can you draw me a cost push inflation
diagram (show SR & LR AS)
7
Draw an Classical AD/AS
diagram
LRAS
Price Level
SRAS2
SRAS1
AD
0
Y2
Y1
Real National
Output
8
Deflation
Is it good or bad?
9
Deflation
• Deflation is a sustained fall in the general
price level
• A sustained period of negative inflation
• The internal value of money rises
10
Deflation for some products
11
What’s the
start the
&
What’s
end
points?
trend?
Describe the changes
in the data provided.
What effects do you
think this had on the
economy?
12
The diagrams
– demand side cause of deflation
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DEMAND PULL Deflation…
LRAS
Price Level
SRAS
AD1
0
Y2
Y1
AD
Real National
Output
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Demand side causes of Deflation
• A Large (adverse) Fall in AD
• Exogenous shocks to the economy
• A global recession leading to a fall in exports
and investment
• A rise in the exchange rate (leading to lower exports and
cheaper imports)
• Declines in domestic and international asset prices
– Deliberate attempts by macroeconomic policy to
reduce AD through tightening of fiscal and/or
monetary policy
15
Multi choice…
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Demand-pull inflation is most likely
to be caused by
• A total spending exceeding productive
capacity.
• B an increase in output.
• C a rise in raw material prices.
• D a rise in interest rates.
17
An economy is most likely to be in the
boom phase of the trade cycle when
there is a rise in
•
•
•
•
A business pessimism.
B the savings ratio.
C spare capacity.
D the demand for imports.
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Real incomes rise whenever
• A nominal incomes rise.
• B the price level rises by more than
nominal incomes.
• C nominal incomes rise by more than the
price level.
• D the rate of inflation slows down.
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Inflation article
• Read
• use highlighters to select key positive &
negative issues
20
What’s so BAD about inflation?
• “RPI is an aggregate figure” – what does
this mean?
• Why are interest rates on mortgages such
an important monetary tool to control
inflation?
• What is the difference between nominal
and real prices?
• The article identifies 4 problems of
inflation. What are they?
21
The diagrams
– supply side cause of deflation
22
SR Cost ‘push’ deflation
LRAS
Price Level
SRAS1
SRAS2
AD
0
Y1
Y2
Real National
Output
23
LR Cost ‘push’ deflation
LRAS
Price Level
LRAS
SRAS1
AD
0
Y1
Y2
Real National
Output
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Supply side causes of deflation
• An Increase in Long Run Aggregate Supply
• The supply potential of the economy has been boosted
by a series of beneficial shocks such as
• Impact of rapid technological advances
• Reductions in the international prices of commodities and capital
goods
• Higher productivity which drives down unit cost of production
– Exploitation of economies of scale leading to lower LRAC
• Excess supply in some industries due to over-investment in new
capital machinery i.e. deflation results from a persistent demand
deficit over existing and potential productive capacity.
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Deflation – good and bad points!
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Consequences of Deflation
• Holding back on spending:
• Consumers may opt to postpone demand if they expect prices to fall
further in the future
• Debts increase: The real value of debt rises when the general price
level is falling and a higher real debt mountain can be a drag on
confidence
– Mortgage payers on fixed mortgage interest rates will see the real cost of
servicing their debt increase
• The real cost of borrowing increases: Real interest rates will rise if
nominal rates of interest do not fall in line with prices
• Lower profit margins: This can lead to higher unemployment as
firms seek to reduce their costs.
• Confidence and saving: Falling asset prices such as price27deflation
Past paper practice
I would suspect that your exam
paper will be about recessionary
issues – one being Deflation!
28
29
QUESTIONS
1. Explain what is meant by the term “deflation”.
(4 marks)
2. With reference to Extract 1, explain the effect on GDP of the
change in asset prices in 1990. (8 marks)
3. Explain why “deflation needn’t be all bad”? (line 28, extract 2) (8
marks)
4. With reference to the extracts, examine the problems associated
with a long period of deflation. (12 marks)
5. Assess the relative effectiveness of using monetary and fiscal
policy to move the economy out of a period of deflation.
(12
marks)
6. How might the continuing deflation in Japan affect the global
economy? (6 marks)
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Or….
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January 2006 - inflation
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The questions
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