Inflation

Inflation

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For other uses, see Inflation (disambiguation).

In mainstream economics, inflation is a rise in the general level of prices, as measured against some baseline of purchasing power.

The prevailing view in mainstream economics is that inflation is caused by the interaction of the supply of money with output and interest rates. In general, mainstream economists divide into two camps: those who believe that monetary effects dominate all others in setting the rate of inflation, or broadly speaking, monetarists, and those who believe that the interaction of money, interest and output dominate over other effects, or broadly speaking Keynesians. Other theories, such as those of the Austrian school of economics, believe that an inflation of the general price level and of specific prices is a result from an increase in the supply of money by central banking authorities.

Related terms include: deflation, a general falling level of prices, disinflation, the reduction of the rate of inflation, hyper-inflation, an out of control inflationary spiral, and reflation, which is an attempt to raise prices to counteract deflationary pressures.

Contents

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1 Measures of inflation

2 The role of inflation in the economy

3 Causes of inflation

3.1 Keynesian Theory

3.2 Monetarism

3.3 Rational Expectations

3.4 Other Theories

3.4.1 Austrian economics

3.4.2 Marxist theory

3.4.3 Supply-side economics

3.5 Issues of classical political economy

3.5.1 Currency and Banking Schools

3.5.2 Anti-Classical or Backing Theory

4 Stopping inflation

5 See also

6 Notes

7 References

7.1 Mainstream

7.2 Austrian

7.3 Left Wing

[edit] Measures of inflation

Measuring inflation is a question of econometrics, that is, finding objective ways of comparing nominal prices to real activity. In many places in economics, "real" variables need to be compared, in order to calculate GDP, effective interest rate and improvements in productivity. Each inflationary measure takes a "basket" of good and services, then the prices of the items in the basket are compared to a previous time, then adjustments are made for the changes in the goods in the basket itself. For example if a month ago canned corn was sold in 10 oz. jars, and this month it is sold in 9.5 oz jars, then the prices of the two cans have to be adjusted for the contents. The result is the amount of increase in price which is attributed to "inflation" and not to improvements in productivity.

This means that there are many measures of inflation, depending on which basket of goods and services are used as the basis for comparison. Different kinds of inflation measure are used to determine the real change in prices, depending on what the context is.

Examples of common measures of inflation include:

consumer price indexes (CPIs) which measure the price of a selection of goods purchased by a "typical consumer".

producer price indexes (PPIs) which measure the price received by a producer. 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 resulting increase in the CPI. Producer price inflation measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" as consumer inflation, or it could be absorbed by profits, or offset by increasing productivity.

wholesale price indexes, which measure the change in price of a selection of goods at wholesale, prior to retail mark ups and sales taxes. These are very similar to the Producer Price Indexes.

commodity price indexes, which measure the change in price of a selection of commodities. In the present commodity price indexes are weighted by the relative importance of the components to the "all in" cost of an employee.

GDP Deflators use an entire economy as the basket of goods and services, rather than some particular subset. The term "deflator" in this case means the percentage to reduce current prices to get the equivalent price in a previous period. The US Commerce Department publishes a deflator series for the US economy.

Purchasing Power Parity adjusts for the inflationary effects of goods being non-tradeable between two or more economies, for example land prices, to compare standard of living purchasing power between two economies. PPP adjustments are, therefore, measuring inflation in location, rather than in time. Many inflation series numbers are also published for particular geographic regions. For example, the US 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. This is equivalent to not adjusting the composition of baskets over time.

Inflation measures are often modified over time, either for the relative weight of goods in the basket, or in the way in which goods from the present are compared with goods from the past. This includes hedonic adjustments and "reweighing" as well as using chained measures of inflation. As with many