TYPES OF INFLATION

Types of Inflation:

COSTS

MONEY SUPPLY

SPECULATION

ADMINISTRATIVE PRESSURES

Types of Inflation
Price Changes Initiated by a Change in
Costs
Cost-push Inflation
Demand-pull Inflation

Types of Inflation
Price Changes Initiated by a Change in
Costs
Cost-push Inflation
If costs rise faster than productivity increases, as
when wages go up, businesses with some control
over prices will try to raise them to cover the higher
costs.

Types of Inflation
Price Changes Initiated by a Change in
Costs
Cost-push Inflation
Demand-pull Inflation
defined as an excessive demand for goods and
services during periods of economic expansion as a
result of large increases in the money supply.
traditionally exists during periods of economic
expansion when the demand for goods and services
exceeds the available supply of such goods and
services.

Types of Inflation
Price Changes Initiated by a Change in the
Money Supply

Types of Inflation
Price Changes Initiated by a Change in the
Money Supply
The way in which factors that affect prices related to one
another is quite complex. More complex relationships
arising out of changes in both the money supply and the
goods side of the equation during business cycles should
also takes place.
When resources such as metals become scarce, they
prices rise. As any resource begins to be used up, the
expectation of future price rises will itself force prices up
because attempts to buy before such price rises will
increase demand above current needs.

Types of Inflation
Speculation and Administrative Inflation

Types of Inflation
Speculation and Administrative Inflation
Speculative Inflation is when an increased money
supply causes Inflation.
It is caused by exaggerated expectations of
future growth, price appreciation, or other events
that could cause an increase in asset values.

Types of Inflation
Speculation and Administrative Inflation

Inflation becomes a self-generating for a time

because, instead of higher prices resulting in
lower demand, people may buy more to get
goods before their prices go still higher (late
1970s) LONG-RUN INFLATION BIAS

In 1980s and 1990s long-run Inflation

stopped but continued low inflation may have
curtailed these beliefs at least for a while.

Types of Inflation
Speculation and Administrative Inflation
Economists believe long-run inflationary bias will
continue in factors:
1.) prices and wages tend to rise during periods of
boom in a competitive economy.
2.) prices tend to remain stable rather than
decrease.
This factors is called Administrative Inflation

Types of Inflation
Speculation and Administrative Inflation
This is to distinguish it from the type of inflation
that happens when demand exceeds the available
supply of goods, either because demand is
increasing faster than supply in the early stages of a
recovery period or because demand from monetary
expansion by the banking system or the
government exceeds available supply.

DEFAULT RISK PREMIUM

Default Risk Premium

Investors are said to be risk averse

(risk-return principle or higher returns) for taking
on more risks.

Default risk is the risk a borrower will not pay

interest or repay the principal on a loan or other
debt instrument according to the agreed
contractual terms.

Default Risk Premium

Nominal Interest Rate

= Real Interest Rate + Inflation Premium +
Default Risk Premium + Maturity Risk Premium +
Liquidity Risk Premium
r = RR + IP + DRP + MRP + LP
DRP = R RR IP MRP LP

Default Risk Premium

r = RR + IP + DRP + MRP +
LP
DRP = R RR IP MRP
LP
Ex : 9% = 3% + 5% + DRP + 0% + 0%
DRP = 9% - 3% - 5% - 0% - 0% = 1%

Default Risk Premium

r = RR + IP + DRP + MRP +
LP
DRP = R RR IP MRP
Another Example :
LP
11% = 3% + 5% + DRP + 0% + 0%
DRP = 11% - 3% - 5% - 0% - 0%
The higher the percentage interest rate the higher
the DRP

table 4.4
March
1980

March
1982

Novem
ber
2001

Novem
ber
2003

Octob
er
2006

Aaa-rated corporate bonds

13.0

14.6

7.0

5.7

5.5

Less: 20-year Treasury

Bonds

12.5

13.8

5.3

5.2

4.9

.5

.8

1.7

.5

.6

Baa-rated corporate bonds

14.5

16.8

7.8

6.7

6.4

Less: 20-year Treasury

Bonds

12.5

13.8

5.3

5.2

4.9

2.0

3.0

2.5

1.5

1.5

Equals: Default risk premium

on Aaa bonds

Equals: Default risk premium

on Baa bonds

The default risk premium of the highest-quality

corporate bonds over Treasury Bonds generally
falls in the range of 0.5 to 0.75 percentage points.

Default Risks Premium

The default risks premiums on Baa corporate

bonds are generally better indicators of investor
pessimism or optimism about economic
expectations than are those on Aaa bonds.

Investors tend to require higher premiums to

compensate for default risk when the economy is
in a recession or is expected to enter one.