The Role of Price Expectations in Inflation

inflation-expectations

A key factor in determining inflation is people’s expectations of future inflation. If firms and consumers expect future inflation then it can become a self-fulfilling prophecy. If workers expect future inflation, they are more likely to bargain for higher wages to compensate for the increased cost of living. If workers can successfully bargain for higher …

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Student discounts – charity or good business?

Companies often offer student discounts – from 10% to 50% off. What is the logic behind this student discount – is it compassionate pricing for hard-up students or is there good economic logic to increase profits for firms? Charging different prices to different groups of consumers is known as price discrimination. The idea is that …

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What is the function of a Central Bank?

A Central Bank is an integral part of the financial and economic system. They are usually owned by the government and given certain functions to fulfil. These include printing money, operating monetary policy, the lender of last resort and ensuring the stability of financial system. Examples of Central Banks include Federal Reserve – US Bank …

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How to avoid a recession

policies-to-avoid-recession

A recession is a fall in real GDP/ negative economic growth. To avoid a recession, the government and monetary authorities need to try and increase aggregate demand (consumer spending, investment, exports). There is no guarantee that they will work. It will depend on the policies and also the causes of the recession. The primary policies …

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Productive Capacity

ppf-consumer-capital-goods

Readers Question: Identify and explain clearly the determinants of a nation’s productive capacity. How does the concept of productive capacity differ from a nation’s actual GDP? A production possibility frontier shows potential output. Here an investment in capital goods enables the PPF curve to shift to the right. Factors that affect productive capacity A nation’s …

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Disinflation – definition and meaning

dinsinflation-cpi-inflation

Definition of disinflation Disinflation is a fall in the inflation rate. It means that the general price level is increasing at a slower rate. When people talk of disinflation, they often mean a period of low inflation. For example, inflation falling below the inflation target of 2%. Between 2011 and 2015, there is a fall …

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Diagram for Negative Externality

A negative externality is a cost imposed on a third party from producing or consuming a good. This is a diagram for negative production externality. This shows the divergence between the private marginal cost of production and the social marginal cost of production. A negative externality leads to overconsumption and deadweight welfare loss. Diagram for …

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Consumer confidence

Consumer confidence is the outlook that consumers have towards the economy and their own personal financial situation. This outlook can be optimistic (high consumer confidence) or pessimistic (low consumer confidence)

The level of consumer confidence will be an important factor that determines the willingness of consumers to spend, borrow and save. A high level of consumer confidence will encourage a higher marginal propensity to consume. A fall in levels of consumer confidence is often an indicator of an economic downturn.

consumer-confidence-uk-oecd Source: OECD

This measure uses 100 as the long-term average for confidence. Therefore, a stat above 100 indicates consumer confidence is higher than average. A value below 100 indicates below average confidence.

Consumer confidence often mirrors the state of the economy

UK-growth-since-2007 Confidence fell sharply during the 2008/09 recession and recovered with the economic recovery.

Factors that affect consumer confidence

  • House prices – Housing is the largest form of household wealth Falling prices reduce wealth and confidence. Rising house prices enable households to ‘re-mortgage’ and gain equity withdrawal.
  • Economic news – Depressing statistics about the global and national economy will reduce confidence and encourage saving rather than spending.
  • Uncertainty – a major political/economic change can lead to uncertainty which reduces confidence. For example, major terrorist attack, uncertainty over Brexit deal.
  • Unemployment – The fear of rising unemployment will discourage consumers.
  • Inflation and real wages. High inflation will reduce confidence. Stagnant and falling real wages will make people pessimistic.
  • Personal debt levels. Rising debt levels will be a source of concern – especially if interest rates rise or the economy slows down.
  • Economic growth – A recession will invariably be associated with a fall in consumer confidence; positive economic growth tends to improve consumer confidence.
  • Current economic situation. Expectations are largely based on the current economic situation and reported the news. News of job losses and falling house prices are amongst the key factors which influence consumer confidence.

Outlook for future UK consumer confidence

If I were a betting man, I would expect consumer confidence to deteriorate over the next 18 months.

  • Squeeze in real wages is reducing spending power.
  • Growing personal debt levels will make consumers vulnerable to higher interest rates or economic slowdown.
  • Prospect of Brexit related uncertainty.
  • Fall in unemployment but growing uncertainty of new jobs in the flexible labour market.

Measuring consumer confidence

cfk-consumer-confidence
This measure plots net positive vs net negative. It shows people more likely to be negative in this period. – rarely does index record net positive score.

 

Consumer confidence is based on qualitative surveys, where people carrying out research ask a sample of the population questions, such as:

  • Do you feel confident about the general economic situation for next year?
  • Do you feel confident about your personal economic situation for next year?
  • Expectations regarding employment conditions six months hence
  • Expectations regarding their total family income six months hence
  • Confidence indexes are often measured in terms of +/-. With a + of 10 meaning, there are a greater number of people optimistic than pessimistic about the future.

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