12.2 Historical Picture of Inflation
3 min read•june 18, 2024
is a persistent increase in prices that erodes purchasing power over time. It impacts consumer behavior, wage negotiations, and economic policy decisions. Understanding inflation is crucial for making informed financial choices and navigating economic landscapes.
Measuring inflation involves tools like the and . Historical trends show periods of high inflation, like the of 1965-1982, and low inflation, like the . Policymakers use monetary and fiscal strategies to control inflation.
Inflation and Its Impact
Definition and effects of inflation
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- Inflation is a sustained increase in the general price level of goods and services over time
- As prices rise, each unit of currency buys fewer goods and services eroding purchasing power
- A gallon of milk that cost 4.00 due to inflation
- A movie ticket that once cost 15, requiring more money for the same experience
Impact on consumer behavior
- Consumer spending habits change during periods of high inflation
- Consumers may reduce discretionary spending as necessities become more expensive shifting towards lower-priced substitute goods or delaying large purchases
- Savers are discouraged as the value of their savings erodes over time
- Wage negotiations are affected by inflation
- Employees may demand higher wages to maintain their standard of living as prices rise
- Employers face increased labor costs, which can lead to reduced hiring or layoffs
- (COLAs) may be incorporated into wage contracts to account for inflation
Measuring and Analyzing Inflation Rates
Measurement of inflation rates
- measures the average change in prices paid by urban consumers for a basket of goods and services
- Calculated by the Bureau of Labor Statistics (BLS) monthly
- CPI is the most widely used measure of inflation
- measures the average change in prices received by domestic producers for their output focusing on prices at the wholesale or producer level
- Personal Consumption Expenditures (PCE) Price Index measures the change in prices of goods and services consumed by households and is favored by the when making decisions
- Expected inflation rates are derived from surveys of economists, businesses, and consumers reflecting the anticipated rate of inflation over a specific future period helping in making investment and financial decisions
Historical trends in U.S. inflation
- Post-World War II period (late 1940s) saw inflation surge due to pent-up demand and supply shortages
- Price controls and rationing were implemented to curb inflation
- The Great Inflation (1965-1982) was characterized by sustained high inflation rates, peaking at 14.8% in 1980
- Caused by expansionary monetary and fiscal policies, oil price shocks (OPEC embargo), and the abandonment of the gold standard
- The Great Moderation (1983-2007) saw low and stable inflation rates, typically around 2-3% annually
- Attributed to improvements in monetary policy, globalization, and increased productivity
- Post-Great Recession (2008-present) inflation remained low despite expansionary monetary policies like
- Federal Reserve adopted a 2% inflation target as a long-term goal
- Recent years have seen a resurgence in inflation due to supply chain disruptions (COVID-19 pandemic) and expansionary fiscal policies (stimulus checks)
Inflation Control and Economic Policy
Monetary Policy and Inflation
- The Federal Reserve uses monetary policy to maintain and control inflation
- Implements to anchor inflation expectations and guide policy decisions
- Changes in the money supply can affect inflation through the
- Faster circulation of money in the economy can lead to higher inflation rates
Fiscal Policy and Inflation
- Government spending and taxation () can influence inflation levels
- Expansionary fiscal policies may stimulate demand and potentially increase inflationary pressures
Economic Relationships
- The suggests a trade-off between unemployment and inflation rates
- This relationship influences policymakers' decisions when addressing economic challenges
Key Terms to Review (23)
Consumer Price Index: The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by consumers for a basket of consumer goods and services. It is a widely used indicator of inflation and provides a snapshot of the overall cost of living in an economy.
Consumer price index (CPI): The Consumer Price Index (CPI) measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. It is a key indicator used to assess inflation and the cost of living.
Core inflation index: The core inflation index measures the change in prices of goods and services, excluding food and energy. It provides a clearer view of long-term inflation trends by omitting the more volatile categories.
Cost-of-Living Adjustments: Cost-of-living adjustments (COLAs) are periodic increases in payments, such as wages or government benefits, to offset the effects of inflation and maintain the purchasing power of the recipient. COLAs are designed to help individuals and households keep up with the rising costs of goods and services over time.
Deflation: Deflation is a sustained decrease in the general price level of goods and services in an economy over time. It is the opposite of inflation, where prices rise, and is characterized by a decline in consumer spending, production, and investment.
Federal Reserve: The Federal Reserve, commonly known as the Fed, is the central banking system of the United States that is responsible for conducting monetary policy, supervising banks, maintaining financial system stability, and providing banking services. It plays a crucial role in influencing inflation and stock market returns.
Fiscal Policy: Fiscal policy refers to the use of government spending, taxation, and borrowing to influence the overall level of economic activity. It is a macroeconomic tool used by policymakers to manage the economy, stabilize business cycles, and achieve desired economic outcomes.
Great Inflation: The Great Inflation was a period of high and sustained inflation that affected many developed economies, particularly the United States, in the 1970s. It was characterized by rapidly rising prices, high unemployment, and economic stagnation, posing significant challenges to policymakers and the public.
Great Moderation: The Great Moderation refers to the extended period of relatively low and stable inflation, along with reduced macroeconomic volatility, experienced by many advanced economies, particularly the United States, from the mid-1980s to the late 2000s.
Hyperinflation: Hyperinflation is an extremely rapid and out-of-control rise in the general price level of goods and services in an economy, often occurring as a result of excessive money creation by the government. It is a severe form of inflation that can have devastating effects on the economic and social fabric of a country.
Inflation: Inflation is a sustained increase in the general price level of goods and services in an economy over time. It is a key macroeconomic concept that has far-reaching implications on the time value of money, business cycles, and personal financial decisions.
Inflation Targeting: Inflation targeting is a monetary policy framework in which a central bank publicly announces an explicit numerical target for the rate of inflation over a specific time horizon and then uses its policy instruments, such as interest rates, to achieve that target. The goal is to maintain price stability and anchor inflation expectations to the target level.
Monetary Policy: Monetary policy refers to the actions taken by a central bank or monetary authority to control the money supply and influence economic conditions. It is a crucial tool used by governments to achieve macroeconomic objectives such as price stability, full employment, and economic growth.
Personal Consumption Expenditures Price Index: The Personal Consumption Expenditures (PCE) Price Index is a measure of the prices paid for household consumption of goods and services in the United States. It is a key indicator used to track inflation and assess the overall health of the economy.
Phillips Curve: The Phillips curve is an economic model that demonstrates the inverse relationship between the rate of unemployment and the rate of inflation in an economy. It suggests that as unemployment decreases, inflation tends to increase, and vice versa.
Price Stability: Price stability refers to the condition where the general level of prices in an economy remains relatively constant over time, with minimal or no inflation or deflation. It is a key macroeconomic goal for central banks and policymakers, as it promotes economic growth, employment, and financial stability.
Producer Price Index: The Producer Price Index (PPI) is a measure of the average change over time in the selling prices received by domestic producers for their output. It serves as an important indicator of inflationary pressures in the economy, as it tracks price changes at the wholesale or producer level, which can subsequently impact consumer prices.
Producer price index (PPI): Producer Price Index (PPI) measures the average change over time in the selling prices received by domestic producers for their output. It is an important indicator of inflation at the wholesale level and can signal changes in consumer prices down the line.
Quantitative Easing: Quantitative easing is an unconventional monetary policy tool used by central banks to stimulate the economy by increasing the money supply and lowering interest rates. It involves the central bank purchasing government securities or other financial assets from the market in order to inject liquidity and promote economic growth.
Siegel: Jeremy Siegel is a finance professor at the Wharton School of the University of Pennsylvania, known for his work on long-term stock market returns and inflation. He authored 'Stocks for the Long Run,' a seminal book in finance literature.
Stagflation: Stagflation is a situation where the economy experiences a combination of stagnant economic growth, high unemployment, and high inflation. It is a challenging economic condition that defies the typical trade-off between inflation and unemployment, as both high prices and weak economic activity occur simultaneously.
Velocity of Money: The velocity of money is a measure of the rate at which money circulates through an economy, or the number of times a unit of currency is used to purchase goods and services within a given time period. It is an important concept in understanding the relationship between the money supply and the level of economic activity.
Yellen: Janet Yellen is an American economist who served as the Chair of the Federal Reserve from 2014 to 2018 and is currently the Secretary of the Treasury. Yellen has played a significant role in shaping U.S. monetary policy, particularly in response to economic crises and inflation.