Inflation: american business - American business
Inflation is a sustained rise in the average level of prices that causes a decrease in the purchasing power of a country’s currency. By decreasing the purchasing power of money, inflation has what economists call redistributive effects. During periods of inflation, people who are on fixed incomes, such as pensioners, as well as holders of bonds and other fixed-interest credit instruments are paid with money that has lost part of its purchasing power. During the economic upheaval in 1990s Russia, retirees with fixed incomes saw their pensions become almost worthless as inflation eroded the purchasing power of their money.
People who borrow in advance of inflation pay back their loans with less valuable money. People who are able to increase their income equal to the increase in inflation do not lose their purchasing power. UNIONs frequently negotiate wage increases to protect their members’ incomes. Often the owners of resources can increase the price of their resources to keep up with inflation.
Inflation is caused by an excess of demand relative to supply, or a reduction in supply relative to demand. Cost-push inflation, sometimes called supply-shock or sellers’ inflation, occurs when a decrease in supply of many or important resources causes an increase in the price of these resources resulting in price increases. The OPEC (Organization of Petroleum Exporting Countries) oil embargo that caused huge increases in oil prices in the 1970s is an example of supply-shock inflation. Demand-pull inflation occurs when overall demand exceeds supply. One way to describe demand-pull inflation is “too many dollars chasing too few goods.” “Too many dollars” in an economy is caused by an expansionary monetary policy or fiscal policy, or some combination of both.
The most extreme example of demand-pull inflation occurred in Germany in the 1920s. At the end of World War I, the German economy was in a shambles. During the war the German government had issued bonds borrowing significant amounts from its citizens, and afterwards it was required to make reparation payments to the Allies. Having little economic activity to tax, the German government literally cranked up the presses, printing deutsche marks. They paid off their debt, but in the process the currency became worthless as inflation increased 100 trillion times between 1914 and 1924. During the worst periods, German workers insisted on being paid twice a day so they could spend their money before it lost more of its purchasing power. One apocryphal story described a German consumer leaving a wheelbarrow full of money outside a bakery while making purchases in the store. Someone stole the wheelbarrow, dumping the money on the sidewalk. The deutsche mark became worthless during this period of hyperinflation.
Inflation in the United States is measured using three indexes: the gross domestic product (GDP) deflator, THE producer price index (PPI) and the Consumer Price Index (CPI). The GDP deflator measures price changes of all goods and services produced. The PPI measures changes in prices received by producers; inflation at the producer level usually precedes inflation at the consumer level. The CPI uses a “market basket” of typical goods and services purchased by households in the United States to measure inflation at the consumer level. The CPI is the most widely watched and quoted measure of inflation and is used in making cost-of-living adjustments.
Boyes, William, and Michael Melvin. Macroeconomics, 5th ed. Boston: Houghton Mifflin Company, 2001.