Question

Explain the indexes for measuring inflation and the pros and cons of inflation ?

Answer 1

CPI: The Consumer Price Index measures the average change in prices over time that consumers pay for a basket of goods and services. CPI is the most widely used measure of inflation

GDP deflator : In economics, the GDP deflator (implicit price deflator) is a measure of the level of prices of all new, domestically produced, final goods and services in an economy in a year. GDP deflator = (nominal gdp/real GDP) * 100

..

Pros of Inflation

Deflation is potentially very damaging to the economy and can lead to lower consumer spending and lower growth. For example, when prices are falling, consumers are encouraged to delay purchasing in the hope prices will be cheaper in the future.

A moderate inflation rate reduces the real value of debt. If there is deflation, the real value of debt increases leading to a squeeze on disposable incomes.

Moderate rates of inflation allow prices to adjust and goods to attain their real price.

Moderate rates of wage inflation, allow relative wages to adjust. Nominal wages are sticky downwards. With moderate inflation, firms can freeze pay rises for less productive workers – to effectively give them a real pay cut.

Moderate rates of inflation are a sign of a healthy economy. With economic growth, we usually get a degree of inflation.

..

Cons of inflation :

High inflation rates tend to cause uncertainty and confusion leading to less investment. It is argued that countries with persistently higher inflation, tend to have lower rates of investment and economic growth.

Higher inflation leads to lower international competitiveness, leading to fewer exports and a deterioration in the current account balance of payments. In a fixed exchange rate, e.g. the Euro – this is even more problematic as countries do not have the option of devaluation.

Menu costs. – This is the cost of changing price lists.

Inflation and stagnant wage growth lead to declining incomes.

Inflation can reduce the real value of savings, which might particularly affect old people who live on savings. However, it does depend on whether interest rates are higher than the inflation rate.