INFLATION

“Inflation Blues”—B.B. King Hey Mr. President; All your congressmen, too,You got me frustrated; And I don't know what to do.

I'm trying to make a living; I can't save a cent.It takes all of my money just to eat and pay my rent.

I got the blues; Got those inflation blues.

You know, I'm not one of those high brows;I'm average Joe to you; I came up eating cornbread, candied yams,

and chicken stew.Now you take that paper dollar; It's only that in name;

The way that buck has shrunk, it's a lowdown dirty shame.That's why I got the blues; Got those inflation blues.

Mr. President, Please cut the price of sugar; I wanna make my coffee sweet;

I wanna smear some butter on my bread, and I just got to have my meat.

When you start rationing, you really played the game;And things are going up, And up and up and up;

And my check remains the same.That's why I got the blues; got those inflation blues.

Introduction—The History of Monetary Inflation in the U.S.

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Definition1. When quantity demanded exceeds

quantity supplies, prices go up and the purchasing power of the dollar goes down.

2. When quantity supplied exceeds quantity demanded, prices fall and purchasing power of the dollar increases.

Causes of Inflation DEMAND—Pull

Aggregate demand increases faster than the economy’s productive capacity

Can result from increases in the money supply or increases in the use of credit

“too much money causing too few goods

Causes of Inflation COST—PUSH (Producers raise prices to

cover higher resource costs)Producers set prices high enough to

cover their costs and make a profitSupply shocks—events that increase

the cost of production—natural disasters, political upheaval, crop failure

Wage/price spiral—higher wages lead to higher prices

Price Expectations When consumers expect a

price increase they tend to spend more now.

As a result, aggregate demand increases, and prices rise.

Measuring Inflation Bureau of Labor Statistics

Use price indexes like the CPI (Consumer Price Index) to measure inflation rate

Consumer Price Indices

Measures the price of a “market basket” of goods

Compares price to a base year (1982-1984=100)

(CPI year B – CPI year A) divided by CPI year A, then times 100

Low to moderate inflation = 1 - 3 %

Food, housing, furniture, clothing, transportation, medical, recreation, education, phones, haircuts, tobacco, services, etc.

Historical CPI

(1982-1984 = 100) 2001 = 177 2002 = 180 1.7% inflation 2003 = 184 2.2% 2004 = 189 2.7% 2005 = 195 3.2% 2006 = 202 3.6% 2007 = 207 2.5% 2008 = 215 3.9% 2009 = 215 0.0% 2010 = 218 1.4%

The CPI “pie”

Effects of Inflation(Does it matter to me?)

1. Decreased Purchasing Power

Same dollar buys less Hurts those on a fixed

income

2. Decreased value of real wages

WASHINGTON (AP) -- American families were squeezed last year as their inflation-adjusted weekly wages fell 1.6 percent -- the sharpest drop since 1990 -- well below the 2.7 percent consumer inflation rate. (Washington Times, Jan. 15, 2010)

3. Increased Interest Rates

As prices increase, interest rates—the price of borrowing money—increase too.

High interest rates can decrease consumer spending

Can double or even triple monthly payments on credit cards and loans

4. Decreased Saving and Investment

Put $2000 in a savings account at 5% interest

In 5 years it equals $2500 If inflation were 7%, you would have

actually lost money You would need $2700 to break

even—to having buying power equal to the $2000 you had 5 years ago.

4. Increased Production Cost

Inflation increases the cost of inputs.

“Paper money eventually returns to its intrinsic value—zero.”

Voltaire—(1694-1778)