Bài giảng Macroeconomics - Chapter 12: Inflation and the Price Level

Chapter 12: Inflation and the Price LevelExplain how the Consumer Price Index is constructed and use it to calculate the inflation rateShow how the CPI is used to adjust economic data to eliminate the effects of inflationDiscuss the two most important biases in the CPIDistinguish between inflation and relative price changes to find the true cost of inflationSummarize the connections among inflation, nominal interest rates, and real interest ratesMeasuring the Price LevelThe Consumer Price Index (CPI) is a measure of the cost of living during a particular periodThe CPI measuresThe cost of a standard basket of goods and services in a given year relative to the cost of the same basket of goods and services in the base year2005 is the base year for the CPIBase year changes periodicallyCalculating the CPICPI is the ratio of the cost of the basket of goods in the current year to the cost in the base yearBase year cost $6802011 cost $850CPI = (850 / 680) (100) = 1.25Cost of living in 2011 is 25% higher than in 2005CPI for the base year is always 1CPI for a given period is the cost of living in that period relative to what it was in the base yearBEA uses CPI as a percentage – the ratio times 100Price IndexA price index measures the average price of a given class of goods and services relative to the price of the same goods and services in a base yearCPI measures the change in consumer pricesOther indicesCore inflation is CPI without energy and foodProducer price indexImport / export price indexInflationThe rate of inflation is the annual percentage change in the price levelInflation in 2006(2.02 – 1.95) / 1.95= 0.036 = 3.6%The Great DepressionPeriod of falling output and prices When inflation rates are negative there is deflationYearCPIInflation20051.9520062.023.6%20072.072.5%20082.153.9%20092.150%Year00CPIInflation19290.17119300.167–2.3%19310.152–9.0%19320.137–9.9%19330.130–5.1%Adjusting for InflationA nominal quantity is measured in terms of its current dollar valueA real quantity is measured in physical termsQuantities of goods and servicesTo compare values over time, use real quantitiesDeflating a nominal quantity converts it to a real quantityDivide a nominal quantity by its price index to express the quantity in real termsIndexingIndexing increases a nominal quantity each period by the percentage increase in a specified price indexIndexing prevents the purchasing power of the nominal quantity from being eroded by inflationIndexing automatically adjusts certain values, such as Social Security payments, by the amount of inflationIf prices increase 3% in a given year, the Social Security recipients receive 3% moreNo action by Congress requiredIndexing is sometimes included in labor contractsAdjusting for InflationAn indexed labor contractFirst year wage is $12 per hourReal wages rise by 2% per year for next 2 yearsRelevant price index is 1.00 in first year, 1.05 in the second, and 1.10 in the thirdNominal wage is real wage times the price indexYearReal Wage1$12.002$12.243$12.48Price Index1.001.051.10Nominal Wage$12.00$12.85$13.73Indexing Avoids DistortionsIncome taxes have been indexed to avoid bracket creepBracket creep occurs when a household is moved into a higher tax bracket due to increases in nominal but not real incomeHigher tax brackets have a higher tax rateIndexing income taxes matches tax rates to the real income levelSuppose the tax rate on $50,000 is 25% in 2000CPI is 1 for 2000, 1.25 for 2005Nominal income of $62,500 is taxed 25% in 2005Distortions Caused by TaxesNot all taxes are indexedCapital depreciation allowance encourages purchase of capital goodsAllows firms to deduct a share of the purchase price as a business expenseIn times of high inflation, investment in plant and equipment decreasesUS tax system is complexTaxes are collected at the federal, state, and city levelsConflicting incentivesTaxes that are not indexed distort the tax incentives for people to work, save, and investLower savings and investment means lower economic growth – a real cost of inflationInflation Increases the Cost of CashIf there is no inflation, cash holds its value over timeSome cash will be held for convenienceWhen inflation is high, cash loses value over timeManage cash balances to limit lossesMore frequent, smaller withdrawals cost consumers and businesses time, travel – a real cost of inflationBanks process more transactions, increasing costs – another real cost of inflationCosts of managing cash holding are called "shoe leather" costs, referring to the cost of frequent trips to the bankUnexpected Redistribution of WealthUnexpected inflation redistributes wealthSuppose workers' salaries are not indexed and inflation is higher than anticipatedSalaries lose purchasing powerEmployers gain at the expense of workersSimilarly, unexpectedly high inflation benefits borrowers at the expense of lendersBorrowers repay with dollars worth less than anticipatedUnexpected inflation confuses incentivesHyperinflationHyperinflation is an extremely high rate of inflationIn 1923, German employers paid workers twice a dayMagnifies the costs of inflationMinimize your cash holdingA study of market economies, 1960 – 1996 showed 45 episodes of high inflation (100+%) in 25 countriesReal GDP/person fell by an average of 1.6% per yearReal consumption/ person fell by an average of 1.3% per yearReal investment per person fell by an average of 3.3% per yearInflation and Interest RatesUnanticipated inflation helps borrowers and hurts lendersThe real interest rate is the annual percentage increase in the purchasing power of financial assetsReal interest rate = nominal interest rate – inflationr = i - The nominal interest rate is the annual percentage increase in the dollar value of an assetNominal interest rates are the most commonly stated ratesInflation and Interest RatesUnexpected inflation benefits borrowers and hurts lendersFor a given nominal interest rate, the higher the inflation rate, the lower the real interest rateExpected inflation may not hurt lenders if they can adjust the nominal interest ratesInflation-protected bonds pay a real rate of interest plus the inflation rateThe Fisher effect is the tendency for nominal interest rates to be high when inflation is high and low when inflation is low