Starter  How could inflation affect you both short term and long term?

Causes and Consequences of Inflation CHAPTER 13.3

Inflation  Inflation--defined two ways  sustained rise in the level of prices generally  sustained fall in the purchasing power of money  Since 1960s, inflation has had significant impact on U.S. economy:  limited stock market growth, increased agricultural bankruptcies  For individuals and economy as a whole  reduced purchasing power of the dollar  raised interest rates

Consumer Price Index  Consumer price index (CPI) measures changes in prices of products  U.S. government surveys people to learn what they buy regularly  creates a "market basket" of about 400 typical products  each month researches current prices of these items  compares prices to reference base, years 1982 to 1984

Producer Price Index  Producer price index (PPI) measures changes in wholesale prices  reflects prices producers get for goods; tied to a reference base  Over 10,000 PPIs for individual products and groups of products  Inflation rate--rate of change in prices over a set period of time  PPI tends to lead CPI as indicator of inflation

Types of Inflation  Moderate rate of inflation--between 1 and 3 percent per year  Creeping inflation--moderate inflation over a period of time  Galloping inflation--rapid increase  Hyperinflation--over 50 percent per month  Deflation--decrease in general price level; happens rarely

What causes inflation?  Demand-pull inflation--total demand rises faster than production  If total demand rises faster than production, it creates scarcity  during lag period, demand pushes up prices for available products  Too much money printed during lag period will drive prices up  Cost-push inflation--increases in production costs push up prices  When production costs increase, producers make less profit  if demand is strong, may raise prices to maintain profits  Cost-push inflation may be due to higher price of materials, energy  Wages can be large part of production costs; wage-price spiral:  higher wages lead to higher costs, which lead to higher prices, which lead to higher wages

Effects of Inflation  EFFECT 1: Decreasing Value of the Dollar  Rising consumer price index represents declining value of the dollar  People on a fixed income are especially vulnerable  each dollar they have buys less every year  Inflation helps people who borrow at a fixed rate of interest  pay debts with dollars that are worth less, so repayments are smaller

Effects of Inflation  EFFECT 2: Increasing Interest Rates  Lenders raise interest rates to ensure profit on loans  Businesses avoid borrowing to expand or make capital improvements  Consumers less likely to finance high-priced items  Monthly credit card payments go up as rates rise

Effects of Inflation  EFFECT 3: Decreasing Real Returns on Savings  Interest on savings tends to increase during inflationary times - but rate of inflation tends to outpace interest rates  Inflation worries people about drop in standard of living, retirement