A reader left a comment asking for helping in finding a 25 year inflation forecast. If anyone knows of anything I would be interested to know about it - I couldn't find anything. Given the limitations in providing 3 year inflation forecasts, I would have thought there are few economists willing to stick their neck out and start predicting inflation for 20 years hence.

I noted here, some of the factors that may affect future inflation, and explained why inflation is difficult to predict.

• Long range inflation forecasts

See also:

• Inflation forecasts for the UK 2007

Labels: inflation

There are many Disadvantages of inflation.

Are there any advantages of inflation?

Firstly it is interesting to note the government's target for inflation is CPI = 2% +/- 1. They have a target of 2% rather than 0%

If inflation is 0% or lower (deflation there can be several disadvantages)

• Deflation can cause lower spending. The value of money is increasing so people wait before buying goods.
• A small amount of inflation makes it easier for the relative price of goods to update.
• Deflation can cause real wages to rise above the equilibrium level. Workers resent a cut in nominal wages. Therefore a moderate amount of inflation enables an increase in nominal wages, without causing excessive real wage rises.

to summarise there are some advantages of having a low rate of inflation e.g. 2%. However, as inflation rises above 2% we start to see the disadvantages outweighing the advantages
Problems recovering from recession

Labels: inflation

Readers Qu. EXPLAIN HOW INFLATION AFFECTS THE FUNCTIONS OF MONEY

Money is said to have four functions


1. Medium of Exchange - used for buying and selling goods.

2. Store of Value: We value goods and wealth through money. Money makes it easy to compare goods

3. Standard of Deferred Payment: Money is used to pay back debt.

4. Unit of Account: prices and accounting records use money


Inflation means an increase in the general price level. An inflation rate of 10% means that the average price level rises by 10%. Inflation means that the value of money decreases. If goods are more expensive a £10 note will buy less over time.

Inflation reduces the effectiveness of money as a medium of exchange. High inflation means that it becomes difficult to place a value on goods because the value of money is always falling. In extreme cases of hyper inflation prices can rise so much that money becomes worthless and people resort to a barter economy. e.g Hungary 1946, Germany 1922

As inflation increases, the volatility of the inflation rate tends to increase. This means that it is harder to place a value on money, thus it becomes more difficult to use it as a store of value.

With a high rate of inflation, the real value of debt erodes. This means that it is effectively easier to pay back the debt. Therefore, in periods of high inflation, banks will be less willing to lend money because they will lose out if people pay back the debt in the future when money is worth less. They will not lend money unless they can charge an interest rate higher than the rate of inflation. If the rate of inflation is stable it is easier to make these calculations.

With high inflation there will be greater Menu costs. This is the cost of changing price lists to reflect the changing value of money.

Labels: inflation

Does cutting taxes lead to inflation?

Cutting Income Tax

• Reducing income tax will increase disposable income of consumers. Therefore consumer spending and AD will increase. This could cause inflation, if the economy is already quite close to full capacity.
• If economic growth is already low, a cut in income tax is unlikely to cause inflation.
• It also depends on consumer confidence. For example, if consumer confidence is very low, a cut in income tax may not lead to extra spending. People may prefer to save the increase in disposable income. Therefore, inflation will not increase in this case.
• It is possible cutting income tax will increase incentives to work and therefore, in the long run AS may increase. However, I feel this effect is very minor.

Cutting Indirect Taxes like VAT

• If the govt cut VAT, from 17.5% to 15% it would effectively increase the spending power of consumers, therefore, there may be an increase in AD and possibly inflation.
• However, a cut in indirect taxes will also directly reduce the RPI measure of inflation. This is simply because many goods will be cheaper because of the reduction in Tax. However, this will be just a one off reduction in the inflation rate.
• Some measures of inflation therefore ignore the temporary effects of taxes.

The effect of lower taxes depends on Government Spending / Borrowing

• The effect of a reduction in taxes also depends on Government spending.
• If the government cut taxes but also reduce government spending, then the net effect on AD will be neutral and there will be no inflationary affect.
• If the Government cut taxes and increase borrowing it should lead to an increase in AD.
• However, some economists will argue a cut in taxes, financed by borrowing will lead to "crowding out" - Private sector buy more bonds so reduce their income.
• Generally, lower taxes may have an inflationary impact, but the actual effect depends on many variables, such as the ones mentioned here.

Labels: inflation

• Inflation measures the increase in cost of living. Basically it refers to the annual percentage increase in the general price level.
• Inflation means that the value of money decreases. Basically, if prices increase it means that £10 will buy less goods than previously.
• Hyper inflation occurs when prices increase at an exponential rate of say over 1000%. When this occurs it creates great instability in the economy. In extreme cases it can lead to a barter economy where people stop using money but trade goods. Examples include Germany in the 1920s and Hungary 1946. Recent examples include Croatia

• Inflation is measured in the UK using the CPI - Consumer Price Index. However, in the past the government used the RPI and RPIX. Some people argue RPI is more accurate because it included housing costs and taxes excluded from the CPI.
• The government has an inflation target of CPI 2% +/- 1%. In the past 10 years, the UK has been relatively very successful in maintaining low inflation.

High inflation is considered harmful to the economy because:

1. It creates uncertainty amongst firms and consumers. This leads to lower investment and economic growth.
2. High inflation is associated with unsustainable economic growth. This leads to the boom and bust situation of the late 1980s
3. High inflation reduces UK's international competitiveness.
4. See also: Costs of inflation
   

• The opposite of inflation is deflation.

Deflation means prices fall. If this is caused by increased productivity and lower costs it is good. however if deflation is caused by an economic recession, then this is considered harmful because falling prices discourages people from spending. The last time the UK had deflation was in the 1930s great depression.

Inflation Links

• Causes of Inflation
• Inflation Explained by Victor Borge
  

Labels: inflation

I'm thinking of investigating why uk inflation has risen in recent months. Obviously there are many reasons but could you highlight a few? or what you think is most important?

Firstly inflation has been a little volatile. For example, after CPI reached a peak of 3% earlier in the year, May inflation fell back to 2.5%. It is worth looking at underlying inflation which ignores volatile goods like energy prices and tobacco. Inflation May 2007

Why Inflation has been rising

1. The bank is concerned primarily in the growth of consumer spending. There is concern this is leading to growth above the underlying trend rate. Growth in consumer spending is coming from various factors such as:

• Lower savings ratio and increased debt. See: why debt has increased in the UK
• Rising House Prices. Booming Housing market creates positive wealth effect and more spending
• High levels of consumer confidence

Evaluation - Why Inflation May Fall

• Interest rate rises take time to have effect. For example, many fixed rate mortgages taken out when interest rates were very low (2003 and 2004) are soon coming to an end. Therefore, homeowners will soon be facing much higher mortgage payments and as a consequence reduce their spending.
  
• Some feel rising house prices are actually causing young consumers to spend less. This is because people fear there is a bubble which will soon burst. Also first time buyers need to save to get on the property ladder
• High levels of debt in the UK, mean that rising interest rates will have a big impact.
• Global inflation is still relatively benign due to process of globalisation e.t.c.
• House prices may set to fall soon - House price fall likely
  

See also: Inflation prospects in 2007

Labels: inflation

Mr P I none off your previous post you said that when explaining low unemployment and inflation you must consider supply and demand factors what are the demand factors

Reasons for Low inflation in UK

Demand side Factors

• Economic growth hasclose to long run trend rate, therefore, avoids inflationary pressure.
• Role of MPC in maintaining inflation close to government's target of CPI 2%. For example, MPC have increased interest rates 4 times in the past 18 months to reduce inflationary pressures.
• High Exchange Rate. This makes exports more expensive and therefore reduces export volumes.
• Diagram could involve a simple AD/AS framework with AD increasing at same rate as AS
  

Supply side factors

• Improved technology, which helps to reduce costs
• Supply side policies
• More flexible labour markets, less wage bargaining. Wage inflation lower (also effects demand pull inflation)
• e.t.c
  

Reasons for Low Unemployment

(demand side)

• Long period of economic expansion. This has created jobs. Draw a simple AD / AS diagram showing an increase in AD and Real GDP
  
• Sustained economic growth and low inflation creates a positive environment for encouraging investment, this has led to increased job opportunities.

Supply Side

Increased labour market flexibility
Improved education and training, for example, the new deal has provided job training to those who need it.

Labels: inflation, readers questions

Q. Discuss Reasons for Low Inflation in the UK? (30)

Despite recent increases in inflation, by historical standards, inflation in the UK is very low (3% as opposed to 10% in 1990). Since independence of the B of England, in 1997, inflation has remained close to the governments target of 2% Many feel the MPC has played a pivotal role in keeping inflation low. However, there are also other reasons to consider such as; globalisation, commodity prices and supply side reforms.

Factors explaining Low Inflation in UK

1. Independent Bank of England - MPC

The MPC has sought to maintain low inflation and sustainable economic growth. It has managed interest rates to avoid inflationary growth. If the economy was expanding too quickly interest rates were increased to prevent future inflation. This is known as pre-emptive monetary policy, interest rates increased BEFORE inflation becomes a problem. As a consequence of this policy, growth has been close to the long run trend rate, and this has been a significant factor in maintaining low inflation.
(AD increasing at same rate as AS)

2. Lower Inflation Expectations

Related to the independence of the MPC, is the fall in inflation expectations. Because people expect low inflation it is easier to create low inflation. For example, workers do not bargain for high wage increases. Firms don't expect to be able to pass price increases on. It is a virtuous circle.

3. International Price trends.

It is not just in the UK that inflation has fallen. Other OECD countries have seen low inflation. For example, the process of globalisation has seen falling prices of manufactured goods, often produced in China. Several commodity prices have also been increasing at low rates, although recently they have started to increased.

4. New Technology.

New technology has helped to reduce the costs of firms. Therefore, the AS curve will shift to the right. For example, the internet and improvements in microchip computers have helped to reduce costs for firms.

5. Supply side reforms in the UK.

Supply side policies implemented since the 1980s have helped to reduce cost push inflation. For example, privatisation has seen public companies become more efficient, leading to lower prices. Privatisation was often accompanied by deregulation, which seeks to increase competition and therefore reduce prices. It is hard to quantify the contribution of supply side reforms to reducing inflation, but, they have had a benefit.


Related Posts

• An Evaluation of MPC in controlling inflation
• Forecasts for Inflation in UK during 2007
• Causes of Inflation
• Bank of England - home to MPC
  
• UK inflation - recent trends at tutor 2U
  

Labels: inflation, UK economy

Markets were disappointed as the Consumer Price Index CPI measure of inflation rose from 2.7% to 2.8%.

The CPI measure is the government's preferred measure. However many feel it doesn't reflect their personal changes in the cost of living. The CPI excludes several items such as: council tax, mortgage costs or house price changes.

The old RPI measure increased to 4.6% driven higher by rising interest payments and council taxe rises.

Inflation Rates for Pensioners

It is estimated that for pensioners the true cost of living may be rising as high as 9.1%. This is because they spend a higher % of their money on things like Gas and council taxes. Pensioners are increasingly indebted as their costs of living rise faster than their incomes. (1) Pension and other benefits are calculated according to CPI inflation.

• Definition Inflation
• Costs of Inflation
• Measuring Inflation

Inflation rate reaches 4.6%

Labels: inflation, UK inflation

To measure inflation the Office for National Statistics needs to find out the 1000 most common items bought in the UK. Each year they conduct a Family Expenditure Survey to find out what people spend their money on. - Measuring Inflation

• Problems of measuring inflation

Recent Items Added to CPI

• Broccoli
• Olive oil,
• Probiotic drinks, such as Yakult and Actimel,
• mobile phone ringtone downloads,
• credit card charges
• and mortgage arrangement fees.

Items Excluded from CPI

• Brie
• VHS recorders,
• video cassettes and
• bulky cathode-ray tube television

Generally food items have been downgraded, services have become more important

The March inflation figures are due out today and are forecast to be around 2.7%

Labels: inflation

Why does MPC and UK government worry about inflation? What are the reasons for having an inflation target of CPI 2% ?

Economics Costs of Inflation

1. Menu costs.

This is the cost of changing price lists e.t.c. However with modern technology this is less significant these days. E.g. Computerised bar codes make it easier to update.

2. Inflation creates uncertainty and confusion.

When inflation is high it also tends to be more volatile. It becomes more difficult for firms to predict future prices and costs, therefore they tend to reduce or delay investment decisions. Therefore this tends to adversely effect economic growth in the long term.

3. Lower Competitiveness

High inflation in the UK makes the UK less competitive compared to other countries. This will reduce demand for UK goods, causing lower growth and possibly balance of payments problems. This is increasingly important with the globalisation of the world economy. If we do lose competitiveness in the long term it is likely to lead to devaluation of the UK exchange rate.

4. Inflationary growth is unsustainable.

In the 1980s the UK experienced economic growth above the long run trend rate, however this also caused inflation leading to a boom and bust economic cycle. Keeping inflation close to the government’s target of 2% is one of the best ways of avoiding inflationary growth and maintaining sustainable economic growth like the UK has experienced since 1992.

5. Inflation reduces the value of savings.

This is because inflation erodes the value of money. This is likely to effect pensioners the most. Therefore inflation is thought to cause a redistribution of income within society from savers to borrowers. However this is only a problem if inflation is higher than the rate of interest. If interest rates are above the value of inflation then savers can still maintain the value of their savings. (so long as they don’t keep it in cash under their bed). This is not really a significant problem in the UK. Real interest rates usually remain positive.

6. Shoe leather costs.

This is the cost of looking around for the best deal. When inflation is high it becomes more difficult to know best deals. However this is only really a problem for very high levels of inflation.

Labels: inflation

Since the Bank of England was given independence in 1997 UK inflation has been close to the government’s target of 2% +/-1. This is a remarkable improvement for the UK economy. Previously the UK economy suffered from consistently high inflation. Eg in 1979 inflation reached 25%. In 1992 inflation reached 11%. Reasons for low inflation are a matter of debate. The chancellor Gordon Brown likes to take credit for giving the Bank of England independence in 1992. However although this partly explains low inflation, it is only a small % of the reason.

Reasons for Low Inflation in the UK

1. Economic growth has been more stable and predictable. The MPC have avoided a boom and Bust economic cycle. At the first sign of inflationary pressures increasing they have increased interest rates to reduce inflation before it occurs (policy is known as pre emptive monetary policy.) This has avoided a repeat of the late 80s inflationary boom.

2. Inflation expectations are lower. Partly as a result of the MPC’s greater credibility. People expect inflation to be low, therefore wage demands have been correspondingly lower. This has made it easier to keep inflation low.

3. The process of globalisation has helped to reduce costs and increase competitiveness in global markets. The UK has benefited from falling prices of manufactured goods that have been made in countries like China and Korea.

4. Improvements in technology. The internet and micro chip computers have helped to increase efficiency and lower costs.

5. Increase in the labour supply. Increased immigration has created a new supply of cheap labour which has helped keep wage pressures low.

6. Appreciation of £. This has helped reduce inflation, because imports are cheaper and quantity of exports lower

However inflation may increase in the future. The Governor of the Bank of England recently said there is no reason why the past period of stability and low real interest rates will continue. Several reasons may cause inflation to rise in the future including:

Why Inflation May Rise

1. Economic growth in China and India is causing high demand for commodities and therefore prices are rising. This will feed through into cost push inflation.

2. The UK has a large current account deficit. To reduce this deficit it will be necessary to have a devaluation in the value of £, at some point.

3. The supply of labour is unlikely to increase by too much in the future. Therefore wage inflation may become a problem as the labour market nears full employment.

4. UK House prices continue to rise. This creates additional consumer wealth and therefore increases consumer spending.

The effect of this is that in the future interest rates may have to rise in order to keep inflation low. This will have the effect of keeping mortgage payments high.

Labels: inflation, UK economy