Introduction to Inflation

Inflation can be measured using CPI (consumer price index) or RPI (retail price index). CPI/RPI takes into account the size of an average family, their average income as well as what they buy (e.g. basic commodities) . They compare the prices of these basic commodities to previous years and determine the rate of inflation from there.

Inflation is when there is a general and sustained increase in the price of goods and services in an economy over a given period of time. Governments aim to keep inflation at a relatively stable rate and the target range for the rate of inflation is generally 0%-2%.

Deflation is the opposite of inflation where there is a general and sustained fall instead of increase.

Disinflation is when fall/slow down in inflation, prices may be increasing but at a slower rate.

The difference between deflation and disinflation is that disinflation is inflation is at a lower rate. Prices will still continue to rise but at a slower rate. While deflation means that prices aren’t increasing at all and are continuously decreasing.

Prices are generally increasing rather than decreasing thus meaning that inflation is more common than deflation. When average price levels increase, buying power decreases.

Inflation affects different people in different ways, for example;

• people with fixed incomes (e.g. those with pensions) are hurt as income stays the same while spending power decreases due to an increase in price.
• Inflation would help borrowers as with inflation, their wages and incomes will increase but their debt would remain the same. They will pay back money that will buy less than it did when they borrowed it.
• Lenders are hurt by inflation since they get payed back with lower valued money.
  • In order to avoid being payed back lower valued money, lenders estimate inflation rates during the time of the loan and set interest rates accordingly.
• Savers are hurt by inflation since their savings are worth less.

As mentioned before, deflation is the opposite of inflation so it would affect people in opposite ways. For example, people with fixed incomes would be helped by deflation as their income stays the same while the prices are decreasing so spending power increases.

Refer to Key Words for Chapter 32