Macroeconomics: Inflation
AAA
  1. Macroeconomics: Introduction and History
  2. Macroeconomics: Schools Of Thought
  3. Macroeconomics: Microeconomics Foundation
  4. Macroeconomics: Supply, Demand and Elasticity
  5. Macroeconomics: Money And Banking
  6. Macroeconomics: Economic Systems
  7. Macroeconomics: Inflation
  8. Macroeconomics: The Business Cycle
  9. Macroeconomics: Unemployment
  10. Macroeconomics: Economic Performance and Growth
  11. Macroeconomics: Government - Expenditures, Taxes and Debt
  12. Macroeconomics: International Trade
  13. Macroeconomics: Currency
  14. Macroeconomics: Conclusion

Macroeconomics: Inflation

By Stephen Simpson

Inflation is a key concept in macroeconomics, and a major concern for government policymakers, companies, workers and investors. Inflation refers to a broad increase in prices across many goods and services in an economy over a sustained period of time. Conversely, inflation can also be thought of as the erosion in value of an economy's currency (a unit of currency buys fewer goods and services than in prior periods).

In the United States, the Consumer Price Index (CPI) is among the most commonly-used measures of inflation. The CPI uses a so-called "market basket" of goods to measure the changes in prices experienced by average consumers in the economy. Economists and central bankers will often subdivide the CPI into so-called "core inflation," a measure that excludes the price of food and energy.

The Producer Price Index (PPI) is a measure of inflation that tracks the prices that producers obtain for their goods. Though a long-followed economic statistic, the change in composition of some economies away from manufacturing and towards services is eroding the value of this statistic. (To learn more about inflation and its indicators, check out Using Coincident And Lagging Indicators.)

The GDP deflator is another option for measuring prices and inflation. As the name suggests, the GDP deflator is a price measurement tool that is used to convert nominal GDP to real GDP. The GDP deflator is a broader measure than the CPI, as it includes goods and services bought by businesses and governments.

While there is little consensus on the "right" rate of inflation for an economy (or even if inflation is necessary at all), there is little disagreement in the differing impacts of expected and unexpected inflation. When inflation is expected, agents in the economy can plan for it and act accordingly – businesses raise prices, workers demand higher wages, lenders raise interest rates and so on.

Unexpected inflation is considerably more problematic. When inflation is higher than expected, it tends to hurt workers, recipients of fixed incomes, and savers. In contrast, unexpected inflation often benefits companies (who can raise prices quickly without needing to raise wages in tandem) and borrowers (who can repay their debts with money that is now worth less than when they borrowed it).

Over the long term, unanticipated inflation can cause a number of problems for an economy. Businesses will invest less in long-term projects because of the uncertainty of returns, price information becomes distorted, and consumers will spend more time trying to protect themselves from inflation and less time engaging in productive activities. Periods of inflation also tend to redirect investment from businesses and toward hard assets, thus depriving companies of the capital they need to grow and expand. (For more on inflation, read What You Should Know About Inflation.)

What causes inflation is also a key argument in economic theory. Some economists believe that there are different types of inflation – cost-push and demand-pull inflation. Cost-push inflation is supposed to be a type of inflation caused by rising prices in goods or services with no suitable alternatives. An oft-cited example of this inflation is the oil crisis of the 1970s. Cost-push inflation is largely a Keynesian argument, as monetarists do not believe that increased prices for goods and services lead to inflation absent an increase in the money supply.

Demand-pull inflation is a rise in the price of goods and services created by aggregate demand in excess of aggregate supply, sometimes referred to as "too much money chasing too few goods." As with cost-push inflation, monetarists argue against the existence of demand-pull inflation absent changes in the money supply. (To help identify the differences between cost-push and demand-pull inflation, read Cost-Push Inflation Versus Demand-Pull Inflation.)

Macroeconomics: The Business Cycle

  1. Macroeconomics: Introduction and History
  2. Macroeconomics: Schools Of Thought
  3. Macroeconomics: Microeconomics Foundation
  4. Macroeconomics: Supply, Demand and Elasticity
  5. Macroeconomics: Money And Banking
  6. Macroeconomics: Economic Systems
  7. Macroeconomics: Inflation
  8. Macroeconomics: The Business Cycle
  9. Macroeconomics: Unemployment
  10. Macroeconomics: Economic Performance and Growth
  11. Macroeconomics: Government - Expenditures, Taxes and Debt
  12. Macroeconomics: International Trade
  13. Macroeconomics: Currency
  14. Macroeconomics: Conclusion
RELATED TERMS
  1. Cost Accounting

    A type of accounting process that aims to capture a company's ...
  2. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s ...
  3. Supply

    A fundamental economic concept that describes the total amount ...
  4. Purchasing Power

    The value of a currency expressed in terms of the amount of goods ...
  5. Monetary Policy

    The actions of a central bank, currency board or other regulatory ...
  6. Principal-Agent Problem

    The principal-agent problem develops when a principal creates ...
RELATED FAQS
  1. What are some examples of positive correlation in economics?

    Positive correlation exists when two variables move in the same direction. A basic example of positive correlation is height ... Read Full Answer >>
  2. How does capitalism work in a mixed economy?

    The standard spectrum of economic systems places laissez-faire capitalism at one extreme and a complete command economy at ... Read Full Answer >>
  3. What kinds of topics does microeconomics cover?

    Microeconomics is the study of human action and interaction. The most common uses of microeconomics deal with individuals ... Read Full Answer >>
  4. What do Keynes and Freidman have to do with fiscal and monetary policy?

    British economist John Maynard Keynes and American economist Milton Friedman were two of the most influential economic and ... Read Full Answer >>
  5. When has the United States run its largest trade deficits?

    In macroeconomics, balance of trade is one of the leading economic metrics that determines the trading relationship of a ... Read Full Answer >>
  6. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!