CIE 3M0 - INFLATION

1. CIE 3M0 - INFLATION CIE 3M0 – Individual and the Economy Mr.T

2. What is Inflation? • Inflation is the increase in the prices of goods & services over a period of time

3. Public Enemy #1? • Inflation takes over as public enemy No. 1 • May 26, 2008 WASHINGTON–Somewhere between the implosion of Wall Street firm Bear Stearns in March and today's $130-plus oil, inflation supplanted the credit crunch as North America's biggest economic worry. • Just a few weeks ago, investors were paralyzed by fears that Bear Stearns could be the first of many financial firms to fall. But the relative calm – and rise in the case of Canada and Mexico – that has settled over markets since then encouraged buyers to tiptoe back into stocks. • Now, the mood is wary once again as oil has surged more than 30 per cent so far this year and economists warn that it is cutting into consumer spending and eroding corporate profits. U.S. stock markets, which had been taking cues from the latest bank rumour, now slide on each new high for crude.

4. How To Increase Your Income Without Doing More Work • Cost of living allowances (C.O.L.A.s) can be calculated in the following manner: • Costs Today / Past Costs x 100%

5. The Consumer Price Index • CPI is a measure of the general changes in market prices of a selected group of goods & services (< 400) purchased by the typical urban (> 30,000) family • Products are weighted according their proportion of total household expenditures with seven components (food 18.1, housing 36.3, clothing 8.7, transportation 18.3, health 4.2, recreation and education 8.8, tobacco / alcohol 5.6 • Current base year 1992 given the number 100 whereas 1990 is 117, which means there was 17 % inflation (Current Year CPI / Base Year CPI x 100%) • CPI, GDP and unemployment rate are the three most commonly used indicators of how the Canadian economy is doing

6. Inflation Since 1940 • 1940 – 42 prices rose rapidly because of WW 2 • 1943 – 45 government controlled prices • 1946 – 49 rapid price increase with end of war • 1951 Korean War drove up prices • 1953 – 65 (low inflation of 1.5%) • 1966 – 72 (higher inflation of 4.8%) • 1973 – 82 (9% inflation) • 1983 – 91 (< 5% inflation) • 1991 - (low inflation of < 2%)

7. Inflation: The Winners And Losers • Those who owe money win and those who are owed money lose. • Inflation Race – expanding businesses, workers in powerful bargaining positions, and those who borrowed money are the winners. Declining industries, workers in weak bargaining positions, and those on fixed incomes lose. • Inflation shifts benefits from creditors to debtors • Hyperinflation or extremely high rates of inflation devastates an economy causing money to become worthless  people turn to barter destroying benefits specialization (higher quality, cheaper products and more leisure time) • Deflation – decrease in the general level of prices over time (Depression 1930s)

8. What Causes Inflation? • Full employment and no inflation is the ideal situation (i.e. full bucket) • Bucket shows real output which is adjusted for inflation so that different year’s outputs can be compared

9. Demand-pull inflation • Demand for goods & services > quantity of goods & services pulls up prices

10. Government policies to control demand-pull inflation • 1. Contractionary fiscal policy – G decreases and T increases which also generates gov’t revenue for use during a recession • 2. Contractionary / Tight Money Policy – Sell bonds, increase the bank rate and use moral suasion to discourage bank loans

11. Applying fiscal and monetary policy to demand-pull inflation • Unemployment – the biggest negative consequence of controlling inflation with contractionary policies • Delays in applying the policy – recognition lag; decision lag; implementation lag;

12. Cost-push / Sellers’ Inflation • When resource costs like wages increase causing producers to pass on the increased costs to consumers in the form of higher priced products • The worst situation is the twin evils of inflation and unemployment existing at the same time stagflation – occurred in the 1970s when OPEC raised the price of oil which was an essential source of energy of the Canadian economy (e.g. bucket has holes on the side that leak)

14. Wage and Price Controls • Policies aimed at restraining inflation by holding wages and prices below a specific level • Successful controls during WW2 but unsuccessful controls in the 1960s and 70s • Lack of united support; large bureaucracy needed; interference with the operation of the market; and import prices all contributed to the lack of success • How would you like it if the gov't said your wage will be frozen?

16. The most confusing part…Money Creation. How do banks do it? • If I deposit $100 in a bank account, the bank must hold that for me. They put it in a chequing account that guarantees that I can convert it back to cash any time. • In doing so, the bank adds that $100 to its assets (because it has the money) and to its liabilities (because it owes me the money). • The money supply has not been changed. • But, if Ms.Wood comes by and asks the bank if she can take out a $90 loan, the bank will check its books and determine that since $100 was added to their assets earlier today, they can loan out 90% of that. Ms.Wood gets her loan. • When Ms. Wood deposits that 90$ into her bank account, it is money that never existed before. It represents an increase in the money supply because my $100 deposit has now turned into $190! • This process can be repeated until the 9:1 ratio is impossible. • This explains why banks "make" so much money, why inflation happens, and why our economy is always growing!