Inflation: Get to the Root of The Problem

Group 1: Hassan NasruJing HengGeorge LimDaniel Kwon

What’s Inflation?

In this inflationary situation, there is no real growth in the output of the economy. It’s simply more money chasing few goods and services.

Is Inflation Good for the Economy?

Consumers

Demand > Supply

Consumer

Demand full inflation

Consumer

Not only priceBut Also GDP

Consumer

Economic Growth

( Advantage )

The amount of currency growth

( disadvantage )

Firms

How does firms cause inflation? Declining Productivity

Firms become less productive and this will allow cost to rise• Labor cost is increasing• It might result in less hiring, which would

damage productivity even further• Unit labor cost = hourly

compensation/productivity

Profit Push Inflation• For monopoly firms to be greedy, they will

maximize their profits.

• Increase their total cost to protect their profit margin, otherwise profits will fall.

• Cause negative sloped demand curve, firms can only change their selling quantity output.

• Output will decrease Cost push inflation

• Caused by an increase in price of inputs, like labor, raw materials etc

• Price increase will lead to a decrease in supply.• Assuming demand constant, the increase in the

price of commodities will cause an increase in the overall price level. This, in essence, will cause cost push inflation

Government

Can cause inflation in two ways: Fiscal Policy (Politically-induced) Monetary Policy (Fed’s decisions)

Government: Fiscal Policy

① Excessive/Lavish Spending (Discretionary & Mandatory) Includes all government consumption, investment

and transfer payments. More often than not, although may not be usually

the case, inflation is caused by high budget deficit due to excessive spending.

Higher deficits lead to inflation in 3 ways: monetary accommodation, crowding out, and private monetization of government debt

② Taxation Low Income TaxInfluence the households to consume more due to an increase in disposable income and purchasing power, thus create a rightward shift in the aggregate demand. High Tax on Goods and ServicesCauses price indices to rise and overall price level to increase, thus creates inflation

Government: Monetary Policy

The Federal Reserves are in control of the supply of money in the market.

Excessive money supply can spur inflation. However, too often the central banks are

politicized, causing inflation to incur unnecessarily. Some of the monetary tools that can cause

inflation are discount rates, open market operations, and reserve requirements.

Effects of Money Supply

Classical and neoclassical economists have argued that money supply is directly proportional to price level, therefore came out with two theories: Fisher Equation (MV=PT) & Cambridge Cash Balance(Md=kPY)

Assuming all variables except money supply(M) and price level(P) remain constant, an increase in M could lead to an increase in P.

Predominant examples are hyperinflations that happen in Hungary, Zimbabwe, Austria and etc.

Conclusion Producers - increase price to raise profit

levels or to respond to higher import prices

Consumers - increase their spending and reduce their saving raising AD

Governments - increase the money supply ,lower direct taxation and run budget deficits and raise indirect

Conclusion

Our take is that government is most influential in causing inflation, given many empirical evidence that was collected from the past: Germany hyperinflation, US 1970s stagflation and such, and the influence it has over consumers and firms.

To avoid inflation, central banks have to be independent and government has to be painstaking while implementing fiscal & monetary policies

Works Cited

"Causes of Inflation." Economics Help. Web. 1 July 2015.Cheah, C. S. "GST Need Not Lead to Higher Inflation All The Time." Bloomberg TV Malaysia. 16 Apr. 2015. Web. 1 July 2015.Humphrey, Thomas. "The Quantity Theory of Money: Its Historical

Evolution and Role in Policy Debates." Federal Reserve Bank of Richmond. Web. 1 July 2015.Miller, Preston. "Higher Deficit Policies Lead to Higher Inflation." Federal Reserve Bank of Minneapolis. Web. 1 July 2015.Rother, Philipp. "Fiscal Policy and Inflation Volatility." European Central Bank. Web. 1 July 2015.Sill, Keith. "Do Budget Deficits Cause Inflation." Web. 1 July 2015.