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Deflation?
Inflation is the general rate at which the level of prices for goods
and services is rising, and as a result purchasing power is falling. In
the UK, low amounts of inflation are seen as a positive thing
(providing stability) and the Bank of England has a symmetrical
target of 2% for inflation (give or take a 1%.) This is the case with
central banks of many developed countries. However, high,
fluctuating rates of inflation historically have not been a positive
thing. An example would be the hyperinflation of Germany because
of debt accumulated during the WW1. On the opposite end of the
spectrum, is the general decrease in prices- often caused by a
decrease in the money supply. This occurred in Britain during the
1930s amid the Great Depression where it was at 2-5%. The
question of whether or not inflation is preferred to deflation is
ultimately about which option offers relative price stability. However,
the type of inflation or deflation that occurs is also significant, the
long and short term costs and benefits, whether or not the economy
is in a boom or recession and the various policies that would have to
be implemented in order to control inflation or deflation.
Inflation, which is generally preferred by developed economies (at
a low level) comes in two types (according to Keynesian economists)
and that is Demand Push and Cost Push. Demand push inflation is
caused by excessive aggregate demand for a certain output. In
increase to AD2, real output and price level would both also increase
to YFE ad P2. Hence, demand deficient unemployment is eliminated,
but this results in some inflation. Once full employment arrives, real
output cannot increase anymore in the short run, as the economy is
now producing at its production on the SRAS curve and an increase
in AD would only lead to inflation, with no output increase. This
however is only short term. Possibly, in the long term, there would
be an outward shift in the PPF boundary of the
economy, which displayed on the right as a shift
from A to B.
Thus, in the long term, demand pull inflation
would be positive is at would lead to increased,
sustainable economic growth as well as an
increase in employment, both of which are
macroeconomic objectives for the economy.
However, it is questionable as to whether or not
this growth and increase in employment is
sustainable. Keynesian economists would argue it
is, as this benefits were created by injecting
money into the economy. If it was a relatively low level of inflation
after the increase to AD2 (first graph) then the growth and
employment would be sustainable. Hence, demand-pull inflation is
in the long term, a positive thing. Although economists would not
call this sort of inflation good inflation because there are still costs
of demand pull inflation. Instead it is considered normal inflation.
Another positive aspect of demand pull inflation, aside from higher
employment and increased economic growth is that it is relatively
easy to control, compared to its counterpart cost push inflation. For
example, if the MPC felt that the economy was growing too strongly
and demand pull inflation was increasing too quickly, they could put
up interest rates to lower the interest rates. There could however be
time lags and it would be difficult to decide when to raise the
interest rates exactly, but policy makers are used to this sort of
inflation and how to get it down or up to their desired target.
However, again this idea of controllable inflation is only applicable
to times of good sustainable economic growth. An example would
be the economy circa 2013. Inflation was well above target but
interest rates could not be raised because the economy was in a
recession and thus unemployment was very low.
Cost push inflation, which is considered by economists as the
wrong sort of inflation is caused by rising costs of production.