Problems of deflation

deflation-inflation-20s-30s

Deflation is defined as a fall in the general price level. It is a negative rate of inflation. The problem with deflation is that often it can contribute to lower economic growth. This is because deflation increases the real value of debt – and therefore reducing the spending power of firms and consumers. Also, falling …

Read moreProblems of deflation

Does inflation cause unemployment?

Readers Question: Does inflation causes unemployment?

There are a few different scenarios where inflation can cause unemployment. However, there is not a direct link. Often we will notice a trade-off between inflation and unemployment – e.g. in a period of strong economic growth and falling unemployment; we see a rise in inflation – see Phillips Curve.

phillips-curve-arrow

Also, it is important to bear in mind, (especially in the current climate) If the economy has deflation or very low inflation and the monetary authorities target a modest rate of inflation, then this may help boost growth and reduce unemployment.

Inflation can cause unemployment when:

  1. The uncertainty of inflation leads to lower investment and lower economic growth in the long term.
  2. Inflationary growth is unsustainable leading to a boom and bust economic cycle.
  3. Inflation leads to a decline in competitiveness and lower export demand, causing unemployment in the export sector (especially in a fixed exchange rate).

Inflation creates uncertainty and lower investment

One argument is that a period of high and volatile inflation discourages firms from investing. Because inflation is high, firms are less certain investment will be profitable. It is argued that countries with higher inflation rates tend to have lower investment and therefore lower economic growth. Therefore, if there are poor levels of investment, this could lead to higher unemployment in the long term.

It is argued that countries with low inflation rates, such as Germany have enabled a long period of economic stability which helps to attain a long-term low unemployment rate. Low inflation in a country like Germany also helps them to become more competitive within the Eurozone, which also helps create employment and reduce unemployment.

See also: costs of inflation

Read moreDoes inflation cause unemployment?

Should low inflation be the primary objective of economic policy?

The UK government has given the Bank of England an inflation target of CPI 2 % +/-1. The Bank of England is responsible for using monetary policy (e.g. interest rates)  to achieve this goal of low inflation. But, as well as targeting inflation, the Bank of England also has a wider remit of considering objectives …

Read moreShould low inflation be the primary objective of economic policy?

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 …

Read moreDisinflation – definition and meaning

UK Inflation Rate and Graphs

Current UK Inflation Rate

  • CPI inflation rate:  3.1% (headline rate) CPI – D7G7 at ONS
  • (page updated 17 Dec 2017)

Other measures of inflation

  • (CPIH) CPI including owner occupiers’ housing costs – 2.8% (CPIH – L550)
  • RPI – 3.9% (Nov 2017)
  • Factory gate prices (Output prices) 3.3% June 2017 (output prices) ONS
  • See: Measures of inflation

Cost-push inflationary factors

In 2017, UK has seen a rise in cost-push inflationary pressures. This has caused a spike in inflation, despite relatively weak economic growth. Cost-push inflationary factors have come from:

  • Devaluation in Sterling. This makes imports more expensive and has fed through into higher input prices for manufacturers.
  • Rise in petrol prices in early part of 2017.
  • Rise in food and recreational goods.

What factors are affecting current inflation rates?

UK inflation post-war

Despite temporary cost-push inflationary factors in 2017, underlying inflationary pressures remain muted – at least compared to the past four decades.

The current UK inflation rate compares favourable to much of the post-war period. The 1970s frequently saw double digit inflation (due to global inflationary pressures from rising oil prices + wage growth). In 2017, the annual CPI is just above the inflation target of 2%.

This is due to:

  • Low worldwide inflationary expectations. Europe is experiencing very low rates of inflation.
  • Fall in global inflation rates since 2007.
  • Supermarket price wars, with big chains, such as Tesco and Sainsbury attempting to maintain market share from Pound Shops and discounters like Lidl.
  • Weaker commodity price growth.
  • Fiscal austerity – many government departments still seeing spending squeezed. In particular public sector pay restraint of 1% has reduced real wages for public sector workers.
  • Private sector wage growth still weak. This has limited costs of firms and limited growth in aggregate demand.
  • Potential negative output gap, with real GDP still around 10-15% below pre-crisis trend rate.

Inflation and wages

  • Real wages = nominal wages – inflation.
  • Usually, during a period of economic growth – wage growth is higher than inflation, this leads to positive real wage growth.
  • During the economic recession of 2009-13 – we had a prolonged period of negative real wage growth. Wages rising at a slower rate than inflation.
  • The end of 2014 saw the first signs of renewed wage growth and positive real wage growth.

inflation-wagesSince 2017, the trend of negative real wage growth has resumed. This low nominal wage growth is one of the major costs of inflation rate of 3%.

See more at UK wage growth

Inflation since 1990

inflation

  • Inflation rose over 8% in the late 1980s due to the Lawson boom, which was a period of unsustainable economic growth.
  • Inflation was low in the period 1992 to 2007. This was a period known as the ‘great moderation’
  • The inflation of 2008 and 2012 was due to cost-push factors (devaluation and rising commodity prices)

Read moreUK Inflation Rate and Graphs

Inflation and Exchange Rates

Readers Question: Why is it that the value of the exchange rate falls when there is higher inflation? How inflation affects the exchange rate A higher inflation rate in the UK compared to other countries will tend to reduce the value of pound because: High inflation in the UK means that UK goods increase in …

Read moreInflation and Exchange Rates

Is zero inflation a good thing?

There are various economic costs associated with inflation – uncertainty, decline in investment, redistribution from savers to borrowers – but although there are costs with inflation, is zero inflation actually desirable? Governments usually set an inflation target of around 2%. (UK CPI target is 2% +/-1) There are reasons for targetting inflation of 2% – …

Read moreIs zero inflation a good thing?

Item added to cart.
0 items - £0.00