Types of Inflation

Inflation→rise in general level of pricing; 2-3% inflation rate is wonderful ($ today can buy less than it did yesterday)
Deflation→decline in general price level (many industrious nations)
Disinflation→occurs when inflation rate itself declines

Solving inflation problems:

• Rule of 70→# of years it takes to double inflation (70/annual inflation rate)
• inflation rate→(current year price index-prior year price index)/prior year price index

Finding real interest rates: (real interest rate=nominal interest rate-inflation)→single digit #s

• Real interest rate→cost of borrowing/lending $ that's adjusted for expected inflation (always expressed as a %)
• Nominal interest rate→unadjusted cost of borrowing/lending $ (expressed as %)

Causes of Inflation:

• Demand-pull→caused by an excess of demand over output that pulls prices ↑; output and emplyment rise while price level is also rising; spending increases faster than production 1) ↑ in govt purchases 2) excessive increases in $ supply (create condition called "hyperinflation"→rapid rise in inflation rate 3) rising incomes as economy approaches full employment output
• Cost-push (supply side economics)→caused by rise in per unit production soct due to increasing resource costs; 2 sources 1) supply shocks→dramatic rise in energy or raw material prices due to input shortages or a growing demand for inputs 2) price wage spiral→where workers seek higher wages to offset higher consumer prices

Effects of Inflation:

-Anticipated~
-Unanticipated: has stronger effects because those expecting inflation may be able to adjust their work/spending habits to avoid/lessen effects
-Both: wages/pensions may have "cost of living adjustments" (COLAs) built in to offset anticipated inflation

1. fixed income groups (ex. grandparents) will be hurt→real income suffers (nominal income does not rise w/ prices)
2. savers will be hurt i.e. inflation takes away from interest earned on account (interest doesn't rise w/ prices)
3. borrowers can be helped by unanticipated inflation while lenders are hurt (debts will be repaid w/ cheaper $ than ones loaned out)