Report: Inflation
By Anas Elshamy
Assalamu Alikum,
Please discuss and share the
different materials, data and issues
regarding the required report on
Inflation
in this post.
Click here and Just type what ever
you want under the box labeled:
Leave a Reply
My Regards.
Tags: Report
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20 November, 2008 at 8:09 pm
this page(wikipedia) have information about inflation just information not indicators Difination , measures , effects , causes….
hope u help u , but sure i know Anas that u have a great information about Inflation u look like that u make a master in inflation sooo this information about inflation is tooooo simple (for poor people like Us).
20 November, 2008 at 9:08 pm
Were is the page Reham?
No any link is provided!
Concerning being a master in inflation
, you will actually find that it is not that much!
I will try to help as much as possible as I can ISA.
21 November, 2008 at 11:54 pm
Anas i think the link reham meant was this
http://en.wikipedia.org/wiki/Inflation
and it is really helpful also i recommend over view the last lectuer of dr. el marakby…& his banflet fot sure…
22 November, 2008 at 12:35 am
Thanks Aya for your clarification.
I hope if were first concentrate on setting standards as to work upon it.
Please, all of you have a look at this link
http://doehelwan.wordpress.com/2008/11/20/chat-room/
22 November, 2008 at 9:37 pm
Egypt Inflation rate (consumer prices)
http://www.indexmundi.com/egypt/inflation_rate_(consumer_prices).html
23 November, 2008 at 2:04 pm
Inflation: http://www.iht.com/articles/ap/2008/06/10/africa/ME-GEN-Egypt-Economy.php – 62k
Official: Egypt’s inflation soars to a 21 percent
CAIRO, Egypt: A government official says inflation in Egypt soared to 21.1 percent in May, as rising prices drive up the country’s food costs.
The official Middle East News Agency quoted head of the Mobilization and Statistics Organization as saying Tuesday that inflation in rural areas increased even higher to 22.9 percent in May.
In March, inflation reached 14.4 percent. About 20 percent of the country’s 76.5 million people live below the poverty line of about $2 per day.
On Saturday, thousands of demonstrators fought with police after a protest over flour rations in a town on Egypt’s Mediterranean coast. In the last two months, 11 people have died in clashes while standing in line to buy subsidized bread.
23 November, 2008 at 2:09 pm
3ala fekra elkalam dah gameed read it and i am waiting for feedback bas take care dah msh elstandards it is just info
24 November, 2008 at 8:03 pm
http://www.kansascityfed.org/PUBLICAT/ECONREV/PDF/2q08billi_kahn.pdf
elsite dah kwayes read it
24 November, 2008 at 8:14 pm
http://www.businesstodayegypt.com/article.aspx?ArticleID=8052
24 November, 2008 at 8:20 pm
http://traderdiary.wordpress.com/tag/egypt-inflation/
24 November, 2008 at 8:26 pm
http://www.freshplaza.com/news_detail.asp?id=17201
24 November, 2008 at 8:26 pm
Assalamu Alikum ya Merit,
the link http://www.kansascityfed.org/PUBLICAT/ECONREV/PDF/2q08billi_kahn.pdf is very interesting…
Can the group of inflation please have a look at it??
It need to be summarized and conclusion brought up as to formulate standards.
My Regards
24 November, 2008 at 8:36 pm
http://en.wikipedia.org/wiki/Inflation
24 November, 2008 at 8:38 pm
Also, this article is so interesting http://www.businesstodayegypt.com/article.aspx?ArticleID=8052
Please read the heading under it titled:
Why is High Inflation Bad?
My Regards
26 November, 2008 at 5:37 pm
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.[1] The term “inflation” once referred to increases in the money supply (monetary inflation); however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflation.[2] Inflation can also be described as a decline in the real value of money—a loss of purchasing power.[3] When the general price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate, which is the percentage change in a price index over time.[4]
Inflation can cause adverse effects on the economy. For example, uncertainty about future inflation may discourage investment and saving. Inflation may widen an income gap between those with fixed incomes and those with variable incomes. High inflation may lead to shortages of goods as consumers begin hoarding them out of concern their prices will increase in the future.
Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply.[5] Views on which factors determine 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, as well as to growth in the money supply. The consensus view is that a sustained period of inflation is caused when money supply increases faster than the growth in productivity in the economy.[6][7]
The task of keeping the rate of inflation low is usually given to monetary authorities who establish monetary policy. Generally today these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.[8]
Origins
Inflation originally referred to the debasement of the currency. When gold was used as currency, gold coins could be collected by the government (e.g. the king or the ruler of the region), melted down, mixed with other metals such as silver, copper or lead, and reissued at the same nominal value. By diluting the gold with other metals, the government could increase the total number of coins issued without also needing to increase 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.[9] This practice would increase the money supply but at the same time lower the relative value of each coin. As the relative value of the coins decrease, consumers would need more coins to exchange for the same goods and services. These goods and services would experience a price increase as the value of each coin is reduced.[10]
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 resource costs of the good, a change in the price of money which then was usually a fluctuation in 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 bank note 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 bank notes outstripped the quantity of metal available for their redemption. The term inflation then referred to the devaluation of the currency, and not to a rise in the price of goods.[2]
This relationship between the over-supply of bank notes 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 to what effect a currency devaluation (later termed monetary inflation) has on the price of goods (later termed price inflation).[11]
Related definitions
The term “inflation” usually refers to a measured rise in a broad price index that represents the overall level of prices in goods and services in the economy. Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCEPI) are two examples of broad price indices. The term inflation may also be used to describe the rising level of prices in a narrow set of assets, goods or services within the economy, such as commodities, which include food, fuel, metals, financial assets such as stocks and real estate, and service industries such as health care. 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 price fluctuations in a sub-set of the broad price index which excludes food and energy prices. The Federal Reserve Board uses the core inflation rate to measure overall inflation, eliminating food and energy prices to mitigate against short term price fluctuations that could distort estimates of future long term inflation trends in the general economy.[12]
Related economic concepts 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 rising unemployment; and reflation, which is an attempt to raise the general level of prices to counteract deflationary pressures.
Measures
Annual inflation rates in the U.S., 1666-2004.
Inflation is usually measured by calculating the inflation rate of a price index, usually the Consumer Price Index.[13][14][15] The Consumer Price Index measures prices of a selection of goods and services purchased by a “typical consumer”.[16] The inflation rate is the percentage rate of change of a price index over time.
For example, 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 2007 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.[17]
Other widely used price indices for calculating price inflation include the following:
• Cost-of-living indices (COLI) are indices similar to the CPI which are often used to adjust fixed incomes and contractual incomes to maintain the real value of those incomes.
• 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.[dubious – discuss]
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 10 oz. 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 average prices of items in the “basket”. A weighted price is calculated by multiplying the unit price of an item to the number of those items 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.[8]
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. Adjustments are necessary over time because the types of goods and services purchased by ‘typical consumers’ changes over time. 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 in order to keep pace with the changing marketplace.
Inflation numbers are often seasonally adjusted in order 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 in order 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.
Effects
This article or section may require cleanup because it is in a list format that may be better presented using prose.
You can help by converting this section to prose, if appropriate. Editing help is available. (September 2008)
1923 Weimar Republic inflation: A German woman feeding a stove with Papiermarks, which burned longer than the amount of firewood people could buy with them.
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 rises, each monetary unit buys fewer goods and services.[18] The effect of inflation is not distributed evenly, and as a consequence there are hidden costs to some and benefits to others from this decrease in purchasing power. For example, with inflation lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers benefit. Individuals or institutions with cash assets will experience a decline in the purchasing power of their holdings. Increases in payments to workers and pensioners often lag behind inflation, especially for those with fixed payments.[8]
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 in order to focus on profit and losses from currency inflation.[8] Uncertainty about the future purchasing power of money discourages investment and saving.[19] And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates.
With high inflation, purchasing power is redistributed from those on fixed incomes such as pensioners towards those with variable incomes whose earnings may better keep pace with the inflation.[8] This redistribution of purchasing power will also occur between international trading partners. Where fixed exchange rates are imposed, rising inflation in one economy will cause its exports to become more expensive and effect the balance of trade. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.
• Inflation destroys the assumption that money is stable which is the basis of classic accountancy. In such circumstances, historical values registered in accountancy books become heterogeneous amounts measured in different units. The use of such data under traditional accounting methods without previous correction, makes no sense and leads to results that are void of meaning. [20]
• Cost-push inflation: Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward trend. This can cause a wage spiral.[21] In a sense, inflation begets further inflationary expectations.
• Hoarding: people buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects.
• Hyperinflation: if inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply.
• 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 in order to carry out transactions this means that more “trips to the bank” are necessary in order to make withdrawals, proverbially wearing out the “shoe leather” with each trip.
• Menu costs: With high inflation, firms must change their prices often in order 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.
• Austrian School explanation of business cycles: According to the Austrian Business Cycle Theory, inflation sets off the business cycle. Austrian economists hold this to be the most damaging effect of inflation. According to Austrian theory, artificially low interest rates and the associated increase in the money supply lead to reckless, speculative borrowing, resulting in clusters of malinvestments, which eventually have to be liquidated as they become unsustainable.[22]
• Inflation erodes the real value of nominally fixed payments – The real value of fixed nominal payments (like rents, pensions, wages, interest, and taxes) are eroded by inflation.[23][24] In many countries, such payments are adjusted for inflation on an annual basis.[25]
• Inflation erodes the real value of historical cost accounting items – The real values of non-monetary assets and liabilities stated at historical cost, (e.g. retained earnings, [26] issued share capital,[27] capital reserves, provisions, taxes, dividends, trade payables and receivables,[28] etc.) – are eroded when they are not inflation-adjusted.[29][30] Two percent inflation – the European Central Bank’s definition of price stability[31] – will erode by 51 percent the real value of historical cost non-monetary items over 35 years.
Some possibly positive effects of (moderate) inflation include:
• Labor Market Adjustments: Keynesians believe that nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and high unemployment in the labor market. Since inflation would lower the real wage if nominal wages are kept constant, Keynesian argue that some inflation is good for the economy, as it would allow labor markets to reach equilibrium faster.
• 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) in order to stimulate the economy – this situation is known as a liquidity trap. A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate.
• Tobin effect: The Nobel prize winning economist James Tobin at one point had argued that a moderate level of inflation can increase investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative to real assets, such as physical capital. To avoid inflation, investors would switch from holding their assets as money (or a similar, susceptible to inflation, form) to investing in real capital projects. See Tobin monetary model[32]
Cost-of-living allowance
For more details on this topic, see Cost of living.
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.[33] A cost-of-living allowance (COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are typically adjusted annually.[33] 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 or cost-of-living increases because of their similarity to increases tied to externally-determined indexes. Most economists and compensation analysts would consider the idea of predetermined future “cost of living increases” to be misleading for two reasons: (1) For most recent periods in the industrialized world, average wages have increased faster than most calculated cost-of-living indexes, reflecting the influence of rising productivity and worker bargaining power rather than simply living costs, and (2) most cost-of-living indexes are not forward-looking, but instead compare current or historical data.
Causes
The Bank of England, central bank of the United Kingdom, monitors causes and attempts to control inflation.
There is broad agreement among economists that in the long run, inflation is essentially a monetary phenomenon. 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.[34] The question of whether the short-term effects last long enough to be important is the central topic of debate between monetarist and Keynesian schools. 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.
A great deal of economic literature concerns the question of what causes inflation and what effect it has. There are different schools of thought as to what causes inflation. Most can be divided into two broad areas: quality theories of inflation and quantity theories of inflation. Many theories of inflation combine the two. 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 equation of the money supply, its velocity, and exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production.
Keynesian view
Keynesian economic theory proposes that money is transparent to real forces in the economy, 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”:[35]
• Demand-pull inflation: inflation caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favourable market conditions will stimulate investment and expansion.
• Cost-push inflation: also called “supply shock inflation,” caused by drops in aggregate supply due to increased prices of inputs, for example. Take for instance a sudden decrease in the supply of oil, which would increase oil prices. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices.
• Built-in inflation: induced by adaptive expectations, often linked to the ”price/wage spiral” because it involves workers trying to keep their wages up (gross wages have to increase above the CPI rate to net to CPI after-tax) with prices and then employers passing higher costs on to consumers as higher prices as part of a “vicious circle.” Built-in inflation reflects events in the past, and so might be seen as hangover inflation.
A major demand-pull theory centers on the supply of money: inflation may be caused by an increase in the quantity of money in circulation relative to the ability of the economy to supply (its potential output). This is most obvious when governments finance spending in a crisis, such as a civil war, by printing money excessively, often leading to hyperinflation, a condition where prices can double in a month or less. Another cause can be a rapid decline in the demand for money, as happened in Europe during the Black Death.
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 economics, 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 economists disagree with the notion that central banks control the money supply, arguing that central banks have little control because the money supply adapts to the demand for bank credit issued by commercial banks. This is the theory of endogenous money. Advocated strongly by post-Keynesians as far back as the 1960s, it has today become a central focus of Taylor rule advocates. 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 influence the money supply by making money cheaper or more expensive, and 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 in order to minimize unemployment. The Phillips curve model described the U.S. experience well in the 1960s but failed to describe the combination of rising inflation and economic stagnation (sometimes referred to as stagflation) experienced in the 1970s.
Thus, modern macroeconomics describes inflation using a Phillips curve that shifts (so the trade-off between inflation and unemployment changes) because of such matters as supply shocks and inflation becoming built into the normal workings of the economy. The former refers to such events as the oil shocks of the 1970s, while the latter refers to the price/wage spiral and inflationary expectations implying that the economy “normally” suffers from inflation. 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.
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 (also see unemployment), 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.
Monetarist view
For more details on this topic, see Monetarists.
Monetarists believe the most significant factor influencing inflation or deflation is the management of money supply through the easing or tightening of credit. They consider fiscal policy, or government spending and taxation, as ineffective in controlling inflation.[36]
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 the total amount of spending in an economy is primarily determined by the total amount of money in existence. This theory begins with the identity:
where
P is the general price level;
V is the velocity of money in final expenditures;
Q is an index of the real value of final expenditures;
M is the quantity of money.
In this formula, the general price level is affected by the level of 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 expenditure () to the quantity of money (M).
Velocity of money is often assumed to be constant, 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 constant velocity, the money supply determines the value of nominal output (which equals final expenditure) in the short run. In practice, velocity is not constant, and can only be measured indirectly and so the formula does not necessarily imply a stable relationship between money supply and nominal output. However, in the long run, changes in money supply and level of economic activity usually dwarf changes in velocity. If velocity is relatively constant, the long run rate of increase in prices (inflation) is equal to the difference between the long run growth rate of money supply and the long run growth rate of real output.[37]
Rational expectations theory
Main article: 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 have economic actors make bets that the economy will expand, believing that the central bank will expand the money supply rather than allow a recession.
Austrian theory
For more details on this topic, see The Austrian view of inflation
The Austrian School asserts that inflation is an increase in the money supply, rising prices are merely consequences and this semantic difference is important in defining inflation.[38] Austrian economists measure the inflation by calculating the growth of what they call ‘the true money supply’, i.e. how many new units of money that are available for immediate use in exchange, that have been created over time.[39][40][41] This interpretation of inflation implies that inflation is always a distinct action taken by the central government or its central bank, which permits or allows an increase in the money supply.[42] In addition to state-induced monetary expansion, the Austrian School also maintains that the effects of increasing the money supply are magnified by credit expansion, as a result of the fractional-reserve banking system employed in most economic and financial systems in the world.[43]
Austrians argue that the state uses inflation as one of the three means by which it can fund its activities (inflation tax), the other two being taxation and borrowing.[44] Various forms of military spending is often cited as a reason for resorting to inflation and borrowing, as this can be a short term way of acquiring marketable resources and is often favored by desperate, indebted governments.[45] In other cases, the central bank may try to avoid or defer the widespread bankruptcies and insolvencies which cause economic recessions or depressions by artificially trying to “stimulate” the economy through ”encouraging” money supply growth and further borrowing via artificially low interest rates.[46] Accordingly, many Austrian economists support the abolition of the central banks and the fractional-reserve banking system, and advocate returning to a 100 percent gold standard, or less frequently, free banking.[47][48] They argue this would constrain unsustainable and volatile fractional-reserve banking practices, ensuring that money supply growth (and inflation) would never spiral out of control.[49][50]
Real bills doctrine
Within the context of a fixed specie basis for money, one important controversy was between the quantity theory of money and the real bills doctrine (RBD). Within this context, quantity theory applies to the level of fractional reserve accounting allowed against specie, generally gold, held by a bank. 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.” Even so, it has theoretical support from a few economists, particularly those that see restrictions on a particular class of credit as incompatible with libertarian principles of laissez-faire, even though almost all libertarian economists are opposed to the RBD.
The debate between currency, or quantity theory, and banking schools in Britain during the 19th century prefigures current questions about the credibility of money in the present. In the 19th century the banking school had greater influence in policy in the United States and Great Britain, while the currency school had more influence “on the continent”, that is in non-British countries, particularly in the Latin Monetary Union and the earlier Scandinavia monetary union.
[edit] Anti-classical or backing theory
Another issue associated with classical political economy is the anti-classical hypothesis of money, or “backing theory”. The backing theory argues that the value of money is determined by the assets and liabilities of the issuing agency.[51] Unlike the Quantity Theory of classical political economy, the backing theory argues that issuing authorities can issue money without causing inflation so long as the money issuer has sufficient assets to cover redemptions.
Controlling inflation
A variety of methods have been used in attempts to control inflation.
Monetary policy
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The U.S. effective federal funds rate charted over fifty years.
Today the primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping the federal funds lending rate at a low level, normally to a target rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% per annum.
There are a number of methods that have been suggested to control inflation. Central banks such as the U.S. Federal Reserve can affect inflation to a significant extent through setting interest rates and through other operations. High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied.
Monetarists emphasize increasing interest rates (slowing the rise in the money supply, monetary policy) to fight inflation. Keynesians emphasize reducing demand in general, often through fiscal policy, using increased taxation or reduced government spending to reduce demand as well as by using monetary policy. Supply-side economists advocate fighting inflation by fixing the exchange rate between the currency and some reference currency such as gold. This would be a return to the gold standard. All of these policies are achieved in practice through a proces
26 November, 2008 at 8:19 pm
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26 November, 2008 at 8:53 pm
the inflation rate:
the rate of increase of a price index (for example, a consumer price index). The rate of decrease in the purchasing power of money is approximately equal.
price index:
If P0 is the current average price level and P − 1 is the price level a year ago, the rate of inflation during the year might be measured as follows:
inflation rate = p0 -p_1
_________ x 100
p-1
After the year the purchasing power of a unit of money is multiplied by a factor 1 / ( 1 + inflation rate/100 ).
There are other ways of defining the inflation rate, such as logP0 − logP − 1 (using the natural log), again stated as a percentage. In this case after the year the purchasing power of a unit of money is multiplied by a factor e − inflation rate.
Methods of controlling inflation:
1.Monetary policy.
2.Fixed exchange rate.
3.Gold standard.
4. wage and price controls.
CPI as akey indicator of inflation:
annual CPI inflation increased to16.4% during april 2008 compared to 14.4% in the previous month and 11.6% last year .the average inflation rate since the beginning of the fiscal year 2007/08 is 10% compared to 11.3% during the same period in 2006/07 with respect to the External sector annual data shows that the balance of payments surplus (4.1% of GDP)reached almost US$ 5.3 billion during 2006/07, notably higher than surplus realized during 2005/06 of almost US$ 3.3 billion , driven by un precedented increases in foreign direct investment (net), non -oil exports and private transfers reaching US$ 11.1,11.9 and 6.3 billion respectively .
current account reciepts ( including official transfers ) continued to outperform current payments bringing the ratio of reciepts to payments to 105.8 % compared to 104.4% in the previous year . Moreover,net international reserves (NIR)-imports coverage ratio increased slightly to 9.1 months compared to 9 months in the previous year . On the other hand ,the coverage ratio of commodity exports to imports decreased to 58.2% compared to 60.6% during FY 2005/06 .