<< Chapter < Page Chapter >> Page >

A preview of policy discussions of inflation

This chapter has focused on how inflation is measured, historical experience with inflation, how to adjust nominal variables into real ones, how inflation affects the economy, and how indexing works. The causes of inflation have barely been hinted at, and government policies to deal with inflation have not been addressed at all. These issues will be taken up in depth in other chapters. However, it is useful to offer a preview here.

The cause of inflation can be summed up in one sentence: Too many dollars chasing too few goods. The great surges of inflation early in the twentieth century came after wars, which are a time when government spending is very high, but consumers have little to buy, because production is going to the war effort. Governments also commonly impose price controls during wartime. After the war, the price controls end and pent-up buying power surges forth, driving up inflation. On the other hand, if too few dollars are chasing too many goods, then inflation will decline or even turn into deflation. Therefore, slowdowns in economic activity, as in major recessions and the Great Depression, are typically associated with a reduction in inflation or even outright deflation.

The policy implications are clear. If inflation is to be avoided, the amount of purchasing power in the economy must grow at roughly the same rate as the production of goods. Macroeconomic policies that the government can use to affect the amount of purchasing power—through taxes, spending, and regulation of interest rates and credit—can thus cause inflation to rise or reduce inflation to lower levels.

A $550 million loaf of bread?

As we will learn in Money and Banking , the existence of money provides enormous benefits to an economy. In a real sense, money is the lubrication that enhances the workings of markets. Money makes transactions easier. It allows people to find employment producing one product, then use the money earned to purchase the other products they need to live on. However, too much money in circulation can lead to inflation. Extreme cases of governments recklessly printing money lead to hyperinflation. Inflation reduces the value of money. Hyperinflation, because money loses value so quickly, ultimately results in people no longer using money. The economy reverts to barter, or it adopts another country’s more stable currency, like U.S. dollars. In the meantime, the economy literally falls apart as people leave jobs and fend for themselves because it is not worth the time to work for money that will be worthless in a few days.

Only national governments have the power to cause hyperinflation. Hyperinflation typically happens when government faces extraordinary demands for spending, which it cannot finance by taxes or borrowing. The only option is to print money—more and more of it. With more money in circulation chasing the same amount (or even less) goods and services, the only result is higher and higher prices until the economy and/or the government collapses. This is why economists are generally wary of letting inflation get out of control.

Key concepts and summary

A payment is said to be indexed if it is automatically adjusted for inflation. Examples of indexing in the private sector include wage contracts with cost-of-living adjustments (COLAs) and loan agreements like adjustable-rate mortgages (ARMs). Examples of indexing in the public sector include tax brackets and Social Security payments.


If inflation rises unexpectedly by 5%, indicate for each of the following whether the economic actor is helped, hurt, or unaffected:

  1. A union member with a COLA wage contract
  2. Someone with a large stash of cash in a safe deposit box
  3. A bank lending money at a fixed rate of interest
  4. A person who is not due to receive a pay raise for another 11 months

Got questions? Get instant answers now!

Rosalie the Retiree knows that when she retires in 16 years, her company will give her a one-time payment of $20,000. However, if the inflation rate is 6% per year, how much buying power will that $20,000 have when measured in today’s dollars? Hint : Start by calculating the rise in the price level over the 16 years.

Got questions? Get instant answers now!


Wines, Michael. “How Bad is Inflation in Zimbabwe?” The New York Times , May 2, 2006. http://www.nytimes.com/2006/05/02/world/africa/02zimbabwe.html?pagewanted=all&_r=0.

Hanke, Steve H. “R.I.P. Zimbabwe Dollar.” CATO Institute . Accessed December 31, 2013. http://www.cato.org/zimbabwe.

Massachusetts Institute of Technology. 2015. "Billion Prices Project." Accessed March 4, 2015. http://bpp.mit.edu/usa/.

Questions & Answers

this means that the demand curve have negative relationship with the price ..which means that when high price low demand of the product and vice versa so higher price will shirnk the demand of product
Ahsan Reply
a person has 60birr to buy two commodities,x and y the price of x is four birr unit the price of y is two birr unit his utility functio given by u=xy+2x determine the budget equation
Mohammed Reply
What are the various reasons for the Federal Reserve to increase the fed rates?
What is unemployment
Mijash Reply
Unemployment is a term used to describe people who do not hold a paying job
what are the causes of unemployment
unemployment refer to the situation in which people searching job but they have no. it also refers in which marginal productivity in zero.
Causes of unemployment are: 1: Over Population 2: Break down of the family system 3: Rural/Urban Migration
unemployment simply means, in the situation where by people are looking for a job and their could achieve it.
suppose you're the economist of ethiopia; when the country is face high rate of inflation what you recommend as one economist?
Roba Reply
if consumer spend all their incomes on consumption what does it mean?
if the government spends more of its revenue on development infrastructure from the budget it have and lower tax collection the budget deficit will run why?
because tax is less than revenue
what is demand
Sunday Reply
Demand is the quantity of goods and services that consumers are willing and able to purchase at various prices over a given period of time
the total value of goods and services produced by a coutry in it's own territorial area( mainly in a year) is called GDP
fareeha Reply
GDP- the total value of goods produced and services provided in a country during one year.
What is the formula for propensity to save
there is no formula for propensity to save but it has a two types one is average propensity to save and marginal propensity to save where Apc is equal to saving divide by income and mpc is equal to change in saving due change in income
yes ooo
what is time in economics?
what is gross domestic product
Moonga Reply
what is macroeconomics
Dickison Reply
what is macroeconomics
Majid Reply
what is macroeconomic analysis
Deogratius Reply
Macroeconomics is a branch of the economics that studies how the aggregate economy behaves. In macroeconomics, a variety of economy-wide phenomena is thoroughly examined such as inflation, price levels, rate of growth, national income, gross domestic product (GDP) and changes in unemployment Read m
Macroeconomics is a branch of the economics that studies how the aggregate economy behaves. In macroeconomics, a variety of economy-wide phenomena is thoroughly examined such as inflation, price levels, rate of growth, national income, gross domestic product (GDP) and changes in unemployment
what is wage in economics?
what is economic
Wajeed Reply
Economics is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. 
Economics is the brench of science that deals with the study of human behavior as it related to end or scare means which have alternative used.
Economics is a science that studies human behavior as a relationship between ends and scarce means which have alternative uses
what is inflation
Junaid Reply
Inflation is simply a situation in an economy where there is a persistent rise or increase in the prices of goods and services in a particular year(say current year)
It can still be defined as a situation in an economy where there's a persistent fall in the value of money
it is the persistent rise in the general price of goods and services in an economy leading to the fall in the values of money
It could mean the central bank has a deficit in reserve unable to cope with low export and exit of foreign investments.
inflation is the general increase in a commodity with in a country.
Mr Fallah please take the definition again that one is not clear
the persistence in general price of commodities
The persistence rise in the general price level
The persistence rise in general price of commodities
what is willingness
Bilal Reply
Is a person Able,Capable and Anxious to something
Is when a person is able,capable and Anxious to do something
thanks sir g.
u are welcome
where you from
And you
How far are you in Education
who about my question What is MPC
is marginal propensity to consume
a little more
sorry muafue sir you are little bit wrong about willingness *willingness reffers how much wants . it could be wants for payment or wants for something to do.
MPC reffers *How much want to consume*.
MPC is Marginal Propensity to Consume. MPC is proportion of additional spent on consumption.
MPC is Marginal Propensity to Consume. MPC is the proportion of additional income spent on consumption.
What is difference between GNP and GDP?
GNP is gross national product. In calculating GNP we include net national income from abroad while GDP is gross domestic product and in calculating it we use on expenditure, income and output from within the country. My name is JERRY NGONDA from Cameron
GNP.the total value of good $service currently produce w a given period of time by domestic owner GNP=NFI+GDP:GDP is a market value of final good $service currently produce in a given period of time w in a country boundery or territors.its take produce currently $etc
yes.no suggestions
good Tade Feyera
Tade Feyera can you send me your whatsap contact number.
when spending by the federal government exceeds net taxes?
stefany Reply
explain the difference between macroeconomics and microeconomics
Macroeconomics is the study of economics at the aggregate level while Micro is at the individual level.
Both indifference curve and isoquant do not intersect TRUE OR FALSE and justify your statement
what is long run and short run period

Get the best Macroeconomics course in your pocket!

Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Macroeconomics' conversation and receive update notifications?