Inflation

Measurement of inflation

The principal measure of inflation is usually taken to be the consumer price index, which is an index of the price of a typical "basket" of goods, collected mainly by surveys of prices charged at retail outlets, and (usually) corrected for quality changes. The term "cost of living index" has often been applied to consumer price indexes, but has sometimes been more broadly interpreted to include the effects upon household welfare of such matters as changes in social security payments. Price indexes of investment goods, imports and exports are also compiled and an average of those indexes, weighted according to the proportions of those items in national income, is used as a "gdp deflator" - and incidentally provides the most comprehensive of the inflation measures. There are also indexes of commodity prices and producer prices.

Causes of inflation

Cost-push and demand-pull

The first-round effect of an external cost shock, such as a sudden increase in the oil price, is a single increase in a range of domestic prices. That results in an unavoidable reduction in domestic purchasing power , but it does not, in itself constitute inflation. Attempts to restore the previous standard of domestic purchasing power by wage increases may be expected to lead to a second round of price increases, however; and expectations of further price increases may be expected to prompt an inflationary succession of repetitions of that sequence. If the general level of demand increases to a level that tends to exceed the productive capacity of the economy, it, too, has the first-round effect of bidding-up prices, which may be expected to generate similar second-round and subsequent effects.

Monetary causes

According to the proponents of monetarism, "inflation is always and everywhere a monetary phenomenon", As propounded by the late Professor Milton Freedman , that theory depends upon the correlations that he discovered in a study of an American business cycle. It is conventionally explained in terms of the stimulation of spending that may be expected to result from the reduction interest rates which follows an increase in the money supply, and upon the consequent price increases and expectations of price increases.