in this video we’re going to look at inflation and inflation of course after gdp is the second of four key economic metrics which determine the performance of the underlying economy so of course we have growth gdp inflation trade and unemployment so this is the second of those four key economic metrics

so inflation is a quantitative measurement of change so it relates to an increase and can be broken down into two separate categories

the first is price inflation and the definition of price inflation is a persistent increase in the general level of prices for goods and services in an economy when the term inflation is used so when you hear people say inflation it is used generally in reference to price inflation so when you hear people say inflation it generally is talking to and referencing a persistent increase in the general level of prices for goods and services within an economy price inflation is measured on a year-on-year basis as opposed to month or month and this provides the most accurate assessment of price changes in inflation data produced using this measuring process is known as being seasonally adjusted so remember stripping out seasonality factors to get a more accurate view of inflation in this case

the second category of inflation is monetary inflation and this is just simply an increase in the money supply so the amount of money in circulation so if there is an increase in the amount of money in circulation this is known as monetary inflation

so we’re now going to look at factors affecting inflation small and stable amounts of inflation are desirable in an economy to help economic expansion and to achieve economic growth and many developed economies around the world have inflation targets of around two percent inflation can be affected from both the demand and the supply side

the three main factors which lead to inflation are so an increase in the amount of money in an economy will lead to inflation and that’ll be monetary inflation

the supply of goods decreasing so this is a shift to the left of the short run aggregate supply curve this is cost push inflation we’ve looked at this in previous videos and this is that shifting to the left of sras because of an increase in the cost of production and demand for goods and services increasing that’s your demand pull inflation so a shifting to the right of aggregate demand so the aggregate demand curve shifts to the right this causes economic growth and an increase in inflation that’s your demand pull inflation

so demand pull inflation is caused by an increase in aggregate demand so shifting to the right of the aggregate demand curve

and aggregate demand increases due to factors such as and we looked at this in previous videos

economic expansion so your consumption and investment increasing increased government spending

and an increase in net exports you’ve got your c plus i plus g plus nx components there forming total aggregate demand within an economy

so a recent example of this so an attempt to shift the aggregate demand curve was the direct payment of up to twelve hundred dollars from the u.s government to u.s citizens and this was to help stimulate growth through an increase in consumption and this would in turn of course if consumption goes up as part of aggregate demand we know this will increase gdp and this will spur demand for inflation it’s that attempt to shift aggregate demand to the right and when you’re talking about monetary authorities you’re talking about governments and central banks they will always be focusing on shifting the aggregate demand curve

money given directly to citizens such as in this example rather than being provided by injections into the money supply is known as helicopter money and if you’re not sure about what the money supply is don’t worry we will be looking at this in future modules so that giving money to citizens is just like money coming out of falling out of a helicopter that’s where it gets its name from it’s just like throwing money out of a helicopter into the streets below demand pull inflation tends to spur economic growth as we’ve seen and this leads to both increased inflation and increased growth it is therefore the preferable form of inflation over cost push inflation and in fact cost push inflation really is not desirable

so cost push inflation is caused by a decrease in aggregate supply so a shifting of the aggregate supply curve to the left

and aggregate supply within an economy in the short term decreases due to an increase in the costs of production

push inflation tends to lead to lower growth so as that sras shifts left we see a contraction in gdp but we see inflation rising and because of this a combination of lower growth and therefore higher unemployment and an increase in the general level of prices within the economy this is an undesirable combination

increased inflation with decreasing or stagnant growth leads to stagflation can lead to deflation

so other key terms related to price changes so related to inflation within an economy that you need to know are

disinflation so disinflation is a slowing of the rate of inflation so prices are still increasing so we still have inflation but at a slower rate so if you have one year inflation at two percent and the next year it drops to one percent you still have inflation because prices are increasing at one percent but they are increasing at a slower rate so disinflation should not be confused with deflation this inflation is inflation but at a slower rate deflation is negative inflation so when the inflation rates drops below zero that is deflation

so deflation is defined as a persistent decrease in the general level of prices of goods and services in an economy so it’s that negative inflation

reflation is a term which is given to the process of using fiscal or monetary policy in order so from governments or central banks in order to expand a country’s output so it’s gdp and slow the effects of deflation so when fiscal or monetary policy is used to shift the aggregate demand curve to the right and stimulate growth decrease unemployment stimulate inflation then this is called reflation and this is very often what you’ll find at the bottom of the business cycle when there has been a recession central banks and governments will step in and they will start to try and reflate the economy with monetary stimulus

stagflation so stagflation is an economic condition where growth is stagnant so it’s slowing or declining but inflation is running high unemployment is also high during periods of stagflation due to the stagnant growth so remember labor is a derived demand if there’s no growth unemployment will increase if there is economic growth unemployment will decrease

and finally we have hyperinflation now you may have heard this term and this is when you have rapid and generally speaking out of control inflation this is what central banks and governments will try to call down the economy to avoid at the top of the business cycle they will try and reduce inflation by taking deflationary measures by raising interest rates for example and it’s to prevent inflation from getting out of control so hyperinflation generally speaking is defined as rises of more than 50 per month and there have actually been some real world examples of this in the not too distant past including in zimbabwe and also we’ve seen more recently in venezuela

so we’re going to look here at measures of inflation so the first measure of inflation which you may have heard is the producer price index and the ppi measures the cost on average because we don’t forget we’re talking about on average the average price of a basket of goods and services and this measures the costs related to producers

the second measure of inflation is core producer price index so cppi and this is the same as the producer price index but it excludes food and energy now the reason for that is because food and energy can be very volatile in terms of pricing and if you are including food and energy when you’re looking at the average level of goods and services within an economy it can distort the overall picture because you may have spikes in food and energy whereas the actual general level of prices haven’t changed too much in the short term

third we have consumer price index the cpi and this is very often what traders will look at in the economic calendar this measures the costs on average of course related to the consumer so they take a basket of goods and services they take the average price of that and they index it so that becomes the consumer price index that becomes the measure of inflation to consumers

and finally we have core consumer price index so the ccpi just as we looked at for businesses so the top part here we are just looking at for businesses and the bottom two here we are looking at to the consumer so measures of inflation to business the first two measures of inflation to the consumer second two so the core consumer price index is simply the same as cpi so it measures the cost on average of a basket of goods and services for consumers but it strips out the food and energy components once again to give a more reliable reading of inflation to the consumer so it takes out the more volatile components to get a better reading of inflation so please download the attached spreadsheet for inflation and we’re going to jump over to that right now so the first tab in this spreadsheet we’re going to look at is the inflation spectrum now on the left hand side here we have the years so we have 2015 2016 2017 2018 2019 2020 and you can see here we have price level now the price level here is the average level of prices of goods and services within an economy so we’re looking at this within an economy and the price level is simply the average prices of a basket of goods within that economy so you could be looking at fuel you could be looking at housing you could be looking at transportation you could be looking at the price of beer which is a real world good which is put into the basket of goods and services which inflation is averaged from and going across we have the month so january all the way to december now you can see if we look at all the way through 2015 we have a price level of one we can look at this let’s say just in dollars for ease one dollar two dollar three dollar four dollars five dollars six dollars seven dollars increasing but importantly we know that inflation is seasonally adjusted so it is gained from comparing january 2015’s price level to january 2016’s price level and you can see there is a jump from one dollars to three dollars and that will give you your annual rate of inflation now if we look down here on the right hand side for december because this is the closest to the data over here you can see that we start off with a general price level in 2015 of 12. this increases to 14 in 2016 which means our annual rate of inflation here and you can see this is pulled from m7 and m4 the annual rate of inflation here is 16.67 so we have in this case inflation because the general level of prices of goods and services within the economy has increased from twelve dollars to fourteen dollars so it’s an increase of two dollars and this is an increase of sixteen point six seven percent this is inflation now if we take our second reading from december 2016 to december 2017 you can see that we have an increase from 14 to 15. now this is still inflation because the general level of prices of goods and services has still increased from 14 to 15 but it is increased by one this is not as large an increase as the previous year the previous year we had an increase of two dollars this year we have an increase of one dollar so inflation but at a slower rate is disinflation so in year two essentially or comparing 2016 to 2017 our second reading here we have disinflation so it’s inflation but at a slower rate it’s a rate of 7.14 compared to 16.67 the previous year if we then take december 2017’s reading of 15 to december 2018’s reading you can see we have a decrease we go from 15 as an average price for goods and services within the economy to 13 as an average price for goods and services within the economy this is deflation it’s a negative change in the inflation index so price is moving up by two dollars from 12 to 14 inflation price moving from 14 to 15 disinflation prices moving from 15 to 13 deflation minus 13.33 percent rate of inflation negative rate of inflation and the following year from 2018 december to 2019 we decrease a gain in prices but you can see in this case we decrease from 13 to 12 so we are now contracting in terms of the rate of inflation at a slower pace because 15 to 13 is a contraction of two dollars 13 to 12 is a contraction of one dollar so we still have a contraction in the rate of inflation but at a slower rate and this may be where the central bank and government have stepped in to stimulate the economy after this contraction after this deflationary period from 1513 and as a result of their policy measures deflation has slowed this slowing of deflation and turning from deflation into inflation is reflation this is here we’re looking at this as the slowing stimulus from central banks and governments slowing the rate of deflation and slowly turning it back into inflation and then if we finally look between december 2019 december 2020 you can see we have an increase of two in the average price level of goods and services within the economy this is once again inflationary so we go from inflation to slowing inflation this inflation here would be phase one of the business cycle slowing inflation or disinflation would be phase two it’s that peaking and reversing we then have deflation so phase three going into that recession and then we have the reflationary phase at the bottom so the slowing of the contraction in inflation and the emergence of new inflation which would kickstart phase one of the business cycle once again