Inflation, Deflation and Hyperinflation

How frequently is the CPI figure calculated in the UK? Who is it calculated by and how?

The CPI figure is produced monthly in the UK by the Office for National Statistics (ONS) and estimated using the consumer price indices.

Example of hyperinflation

In Venezuela, the International Monetary Fund (IMF) predicts that prices will rise by 13,000% in 2018.

What are the strategies used to control inflation?

Interest rates and money supply.

How can PSNCR be measured?

It can be measured as an amount of money, or as a percentage of GDP.

M1

M0 Financial assets that can be converted into cash at short-notice.

Measures that are used in relation to the level of money supply

M0 M1 M2 M3 M4

M2

M1 Sterling time deposits

M3

M2 Long-term deposits Institutional money market funds

M4

M3 Bank acceptances Debt instruments issued by financial institutions including commercial paper and bonds with a maturity of up to five years

Retails Sales Index (RSI)

Measures the monthly movement in the average weekly turnover of UK retailers, which is taken as an indicator of consumer confidence. Goods sold on the internet are not included in this index.

An increase in the money supply leads to

More money in banks available to be lent More lenders resulting in lower interest rates Consumers and businesses have more money to spend, boosting economic activity Consumer confidence increases A rise in stock markets A rise in prices Inflation

Money supply directly influences

Prices, inflation and the business cycle.

Public Sector Net Cash Requirment (PSNCR)

Represents the annual fiscal deficit, meaning the amount of money that the government needs to borrow to finance its expenditure. Represents the shortfall between tax revenue and government expenditure.

In the UK what is the interest rate called?

The Bank of England Base Rate

How do interest rates affect the economy?

The economy relies on borrowed money so the amount of interest charged on borrowed money directly influences the demand for such loans as the lower the interest, the more appealing the loan. The lower the interest rate, the cheaper it is to borrow money. More money will be spent, boosting the economy. If the interest rate increases, borrowing becomes more expensive and saving becomes more attractive. Less money will be spent, slowing down the economy. A change in interest rates is an indirect tool as it takes several months to have an impact on the economy. Therefore, many governments overreact in the use of interest rates in order to control the economy.

What can hyperinflation be caused by?

The government printing excessive amounts of money.

Inflation Definition

The increase in the price of goods and services over time. Often measured over a 12 month period.

Consumer Price Index - Housing (CPI-H)

When housing costs, such as council tax, are included in the CPI figure.

Disadvantages of QE

Inflation / hyperinflation Social inequality Banks might not lend money

Deflation

The decrease in the price of goods and services over time.

How does QE work?

A central bank purchases assets, mostly gilts, from retail banks using electronic money, giving these banks more money available for lending. Assets are also purchased from large institutions, such as pension funds, in the hope that they will reinvest the proceeds into other high-yield investments such as equities or corporate bonds. As demand for these financial assets increases, their prices rise, lowering their yields, causing yields in general to fall. This results in cheaper borrowing, which then encourages spending. If inflation is too high, the assets purchased by the central bank can then be sold through QE to reduce the amount of money and spending in the economy.

Retail Price Index (RPI)

A general measure used in the UK for pensions, benefits and and index linked bonds.

Hyperinflation

A very rapid inflation that leads to a complete loss of confidence in the sustainable purchasing power of a country's currency. It can lead to economic collapse.

Quantitative Easing (QE) Definition

An instrument a central bank uses to bring down interest rates for companies and households by creating money electronically in the economy.

Interest Rates Definition

An interest rate is the charge made for a loan / paid on a deposit and is normally expressed in terms of a percentage per year.

Knock-on effect of inflation

As inflation rises, prices rise, the purchasing power of money decreases and the cost of living increases.

What is QE also known as?

Asset purchasing

Advantages of QE

Boosts spending Flexible policy Avoids deflation

How can PSNCR be financed?

By issuing gilts Increasing the narrow money supply Borrowing from overseas

Consumer Price Index (CPI)

CPIs are monthly indicators that show the rate of inflation or deflation. CPIs record changes in the price of a basket of goods and services that a normal household purchases.

M0

Ceased to be used in the UK in May 2006 when the Bank of England introduced its Money Market Reform. Also referred to as the monetary base as it was the base on which other forms of money were based. Refers to the most liquid form of money, being cash. This includes notes and coins in circulation outside the Bank of England and banks' balances at the Bank of England.

How is inflation measured?

Consumer Price Index (CPI) Retail Price Index (RPI) Retail Sales Index (RSI)

Problems associated with inflation

Erosion of the real value of money and of financial assets, particularly low-interest earning bank deposits. Undermines two of the key functions of money: To be a store of value. This is because as inflation increases, its value decreases. To be a medium of exchange, particularly if hyperinflation occurs. People may refuse to accept certain currencies.

Impact of hyperinflation

The purchasing power of money increases which may be good for individuals with a high disposable income. It may lead to a fall in demand. This is because as prices continue to fall, people will stop spending money on goods and services in the hope that prices will fall further, putting pressure on manufactures for cheaper prices. It is likely to be an indicator of a recession or a depression.

Money Supply

The total quantity of money in circulation within an economy.

What happens if wages fail to keep up with a country's inflation rate?

This will result in a decline in the standard of living.

Aim of QE

To boost the economy to reach an inflation target when interest rates are already low.