Inflation

Revision: Inflation Targets and Measurement

Revision on inflation targets and the inflation measurement issue. Tim Harford’s Radio 4 Programme ‘More or Less’ this week looked at the issue of inflation measurement

Revision PowerPoint
Inflation_Targets.ppt

Loss aversion and experiences of inflation

Few people believe that the officially published measure of inflation accurately captures their own experiences and problems - this is hardly a surprise since our own spending patterns will rarely correlate precisely with the weights used to calculate the consumer price and retail price index. But there is a real danger that the published inflation figures are losing credibility - and with it comes a risk of a larger-than-expected wage-price effect into 2009.

David Leonhardt writing in the New York Times links aspects of behavioural economics to the vexed question of just how high is inflation. A really interesting piece and well worth reading:

“Price increases are simply more noticeable — more salient, as psychologists would say — than price decreases. Part of this comes from the notion of loss aversion: human beings dislike a loss more than they like a gain of equivalent size. If you have to sell your house for less than you bought it for, you’re really unhappy. You hate that ground chuck now costs $2.83 a pound, but you didn’t notice that oranges are 31 percent cheaper than they were a year ago. There is also something particular to inflation that aggravates loss aversion. Price increases are obvious. But price declines are often hidden. The cost of an item stays about the same for years, while everything else gets more expensive and nominal incomes rise.”

The rest of his piece is here

Gordon’s economic history lesson

It cannot have been easy or much fun for the man. Gordon Brown’s appearance on the Andrew Marr show this morning was supposed to have been the start of the big fight-back after the appalling drubbing that he suffered at the polls on Thursday and Friday. But the garbled mixture of reassurance and platitudes about the government ‘feeling our pain’ was distinctly underwhelming. I winced ahfl way through the interview when Brown claimed that the last Labour government inherited high inflation from the Conservatives. This is simply not true. I applaud his decision to give independence to the Bank of England in May 1997, but low and (relatively) stable inflation did not appear miraculously when Blair walked into Number 10 that year - consumer price inflation (the government’s chosen emasure, but not one that most of us now look at with much credence) was already low for some years before 1997 as our chart shows. Inflation targets (introduced in the UK in 1992 after our departure from the ERM) and a favourable mix of disinflationary economic shocks, globalisation and the strong exchange rate combined to give Brown and his Treasury team an inheritance of low inflation when they came to power. Perhaps it was the stress that caused Brown to make such a shocking mistake in his attempt to teach us all a little economic history?

An end in sight for hyperinflation in Zimbabwe?  It can’t get worse, can it?

Official figures show that Zimbabwe’s soaring inflation hit an annual rate of almost 165,000% in February.  Continuing shortages of food and fuel helped to push up inflation from January’s rate of 100,000%.

Zimbabwe is tipping into economic oblivion in response to the crazy policies of its resident tyrant, Robert Mugabe.  Once the ‘breadbasket’ of southern Africa, about 80% of the country’s population now lives in poverty and it is estimated that three million people have left the country for a new life in South Africa.

Staple goods are scarce and the government responds to shortages by increasing the supply of money.  The central bank has introduced new banknotes to cope with the spiralling prices, recently issuing a 10 million Zimbabwe dollar note.

Chart of the Day: Imported Inflation into the UK

Our chart for the day is linked to the news that the pound has fallen to an historic low against the Euro. One of the consequences of a depreciating currency is that the prices of many of the goods and services we import from overseas goes up potentially leading to a fresh burst of cost-push inflation.

Revision: Cost push & demand pull inflation

This revision note considers two of the main causes of inflation – namely cost-push and demand-pull factors. It is designed for AS economists preparing for Unit 2 but is also useful revision for students revising for unit 6.

Revision note file
Revision_Causes_of_Inflation.pdf

Policy conflict for the UK economy?

The IMF is forecasting a slowdown in global growth to 3.7% in 2008 and 2009. This is in contrast to recent growth rates of over 5%.

Chart of the Day: UK Shop Prices

There are few signs so far that the fall in the UK exchange rate against the Euro and accelerating inflation in costs and prices in China are yet showing through in the prices we pay for non-food items in the shops.

Deflation in Goods

I have an admission to make. A few weeks ago I inadvertently dropped my digital camera and my Blackberry into a toilet during a rest-stop at Portsmouth FC’s training facility! The camera is now useless but the Blackberry survived intact and working fine!

Having decided to replace the camera I find on Amazon.co.uk that the same make is available for twenty per cent less than at the same time last year and perhaps a good example of the heavy rate of annual price deflation in the prices of household goods in the UK. In part this helps to explain why the official measures of inflation captured by the CPI and RPI remain relatively low despite sharply rising food, fuel and utility bills. But critics of the RPI and CPI calculation retort that few households replace their household goods every year – so price reductions have little direct impact on their annual cost of living. The Times covered this trend in an article in yesterday’s paper.

“According to Pricewaterhouse-Coopers (PwC), the accountants, the prices of everything from a kettle to a camera have tumbled by nearly 50 per cent since the early 1970s…..The biggest price-cuts have come in the past decade, as retailers have taken advantage of improvements in technology, the manufacture of products overseas and, most recently, the depreciation of the dollar against the pound.”

How long can this price deflation last? The pound is falling against the Euro and marking time against the US dollar, there is plenty of evidence of surging cost and price inflation in China and other emerging market countries.

Stephen King savages rigid inflation targets

Stephen King, Chief Global Economist at HSBC is brilliant in today’s Independent - attacking the rigid adherence to an inflation target based solely on the rate of change of consumer prices and ignoring asset price deflation. One of the best comment pieces on macroeconomic policy that I have read in a long time.

“The rigid adherence to an inflation target in a world of constant external shocks may sometimes be more a source of instability than of tranquillity. With sizeable relative price shocks stemming from globalisation, the risks of instability are all the greater. Even worse, if the public thinks that price stability is the only litmus test of economic health, the achievement of low inflation may encourage excessive risk-taking which, in turn, could undermine the achievement of broader economic objectives.”