macro policy revision宏观政策修正

MacroPolicyRevisionAS2014ReviewQuizWhichofthefollowingpoliciesismostlikelytobesuccessfulinalleviatingabalanceofpaymentsdeficitinafullyemployedeconomy?AcurrencydevaluationandeasiermonetarypoliciesAcurrencydevaluationandtightermonetarypoliciesAnupwardscurrencyrevaluationwithhighertariffsAnupwardscurrencyrevaluationwitheasiermonetarypoliciesAnupwardscurrencyrevaluationwithtightermonetarypolices.Alleviatemeansimprovethesituation;tightermonetarypolicymeansincreasingtheinterestrateandreducingthemoneysupply.ReviewQuiz2.Whichofthefollowingwouldbeleastlikelytoresultinanincreaseinexports?AneasingofconsumercreditrestrictionsAdepreciationintheexternalvalueofthecurrencyAreductionintherateofcorporationtaxAnincreaseinthemarginalpropensitytosaveAriseinunemploymentlevelsReviewQuiz3.Ifthepricesofacountry’sexportsrisemorethanthepricesofitsimports,whichofthefollowingmustbetrue?Thetermsoftradehavedeteriorated,(eworse)ThetermsoftradehaveimprovedTotalforeigncurrencyreceiptsfromexportsriseTherewillbeanincreaseddeficitorareducedsurplusonthebalanceofvisibletradeTheexternalvalueofthecurrencywillfall.AnswersAcurrencyrevaluationlowersexportpricesandraisesimportpriceswhichhelpsthebalanceofpayments.AnupwardrevaluationcannotdothissoC,DandEareeliminated.Bistheanswerbecauseeasiermonetarypolicy,(lowerinterestrates)asinA.wouldraiseinflationandinflationisbadforthebalanceofpaymentsAnswers2.Afallintheexchangerateincreasesexports,(B),afallincorporationtaxwillincreaseeconomicactivityandsoexportswillrise(C).Increasedsavings,(D),reducesimportsandsodoesunemployment,(E).FirmsmaycompensatebyincreasingadvertisinginforeignmarketssoExports

mightrise. TheanswerisAwhichwillincreaseimportsbuthavelittleornoeffectonexportsAnswers3.Thisissimplyamatterofproperuseofadefinition.C,D,andEmightbetrue,butonlyBmustbetrue.Cdependsonpriceelasticityofdemandforexports–ifinelastic,risingpricesincreasesrevenues.DandEalsodependontheeffectofthepriceriseandaredependentonconsumertastesandpriceelasticitiesofdemandforexports.Aisjustwrong.ASMCQsAcountryexperiencedanannualinflationrateof4%forthreesuccessiveyears.Whichstatementiscorrectforthethree-yearperiod?AThepricelevelroseby12%.BThepricelevelrosebymorethan12%.CTherealvalueofmoneyroseby12%.DTherealvalueofmoneyrosebymorethan12%.ASMCQsThereisariseintheexchangerateoftheUS$.WhichwouldcausethegreatestincreaseintheUScurrentaccountdeficit?AahighlevelofdomesticunemploymentBahighpriceelasticityofdemandforimportsCalowpriceelasticityofdemandforexportsDalowrateofdomesticinflationASMCQsASMCQsMCQsMCQsMCQsMCQsMCQsFinishedYouhavereachedtheendoftheASlevelsyllabusandfromnowonwewillonlyberevisingthetopicswehavecoveredsinceAugust2013WellDone!KeepuptheHardWorkEssayRevisionWiththeaidofadiagram,explainwhyaneconomy’sfloatingexchangeratemaydepreciate.[8]Discusswhetheracurrentaccountdeficitisalwaysaseriouseconomicproblemforacountry.[12]StrategyWiththeaidofadiagram,explainwhyaneconomy’sfloatingexchangeratemaydepreciate.[8]DefineTermsExplainthechangesExplainwhatmaycausethechangestooccurIncluderelevantdiagram(s)StrategyDiscusswhetheracurrentaccountdeficitisalwaysaseriouseconomicproblemforacountry.[12]DefinetermsThinkaboutlongtermvs.shorttermDiscussreasonswhyadeficitisorisnotaproblem(a)“…giveacceptabledefinitionsofafloatingexchangerateanddepreciation.”Depreciationisafallinthevalueofacurrencywhichisfixedbymarketforces.Thefallmayhavebeentheresultofafallindemandoranincreaseinsupplyofthecurrency.Possiblecausesincludealossofinternationalcompetitiveness,lossofforeignconfidenceandchangesininternationalinvestmentflows.Referencetobothsupplyanddemandneededforfullmarks.Forunderstandingofadepreciatingfloatingexchangerate2marksFordiagramillustratingthedepreciation2marksForexplanationofthefactorsbehindthedepreciation4marks(b)Acurrentaccountdeficitoccurswhenfinancialoutflowsfromgoods,services,eandtransfersoutweighinflows.Thismaybeaseriousproblemifitistheresultofafundamentaldisequilibrium,ifitrequiresunusualpolicymeasures,ifitislongtermandifitisnotpossibletofinanceitwithoutexcessiveborrowingorrundownofreserves.However,itmaynotbesignificantifitalternateswithsurplusyears,therearesufficientreservestocoverit,ifitwillenablelongertermdevelopment(viatheimportingofcapitalgoods)andifitisasmallpercentageofGDP.Othereconomicproblems(inflationorunemployment)maybemoresignificantdependinguponeconomicconditions.Forunderstandingofacurrentaccountdeficit4marksFordiscussionofcircumstanceswhenitisserious4marksFordiscussionofcircumstanceswhenitisnotserious4marksBalanceofPaymentsAcommonissueforstudents,(andexperts!),istheideathatthebalanceofpaymentsalwaysbalances.Thismeans;CurrentAccount+Capital(Financial)Account=0Howisthispossible?BalanceofPaymentsTheBofPisanaccountingdocumentthatfollowstherulesofdoubleentrybookkeeping.Thismeansthatwehavetorecorddebitsandcreditsforeachtransaction.Let’sgothroughanexampleofthis:BalanceofPaymentsIfyoubuyaMercedescar,whataretheflowsofmoniesinvolved?

YougototheMercedesshowroomandbuythecarusingpounds.ThismoneywillendupbackinGermany.ButtheGermanownersofMercedesdonotwantthemoneyinpounds.TheywillwantEuros.BalanceofPaymentsMercedeswillthengototheforeignexchangemarketandtradethepoundsforEuros.OntheUKcurrentaccount,thevalueofthecarwillappearasadebititem:themoneyflowsoutOnthecapitalaccount,thepoundswillappearasacredititemBalanceofPaymentsLet’sconsiderapersonalfinanceexample:Anindividualscurrentaccountcouldshowthefollowingdebitsandcredits:ItemCreditDebite25000eformInvestment1000GoodsandServices18000House60000Total2600078000SURPLUSor(DEFICIT)(52000)BalanceofPaymentsThiswouldbebalancedonthecapital(financial)accountlikethis:ItemCreditDebitLoan50000Cashfromsavings2000Total52000SURPLUSor(DEFICIT)52000BalanceofPaymentsSoifyoubuyaforeignproduct,yourexpenditureshowsupasadebitonthecurrentaccount,(specificallythetradebalance).E.g.youbuyaCDfromtheUSAforRMB100Onthefinancialaccount,theUScompany’sbankaccountinChinaiscreditedwithRMB100BalanceofPaymentsThisgoesbacktotheideathatwecannotspendRMBintheUSA.SotheUScompanywantsUS$,itneedstoexchangetheRMB100intheforeignexchangemarket.InthefinancialaccountthisshowsthatthecountryhasmoreRMBandfewerUS$NextessayforrevisionMacroeconomicProblems

InflationAS.1and2TheGeneralPriceLevelandPriceIndicesWhatisthegeneralpricelevel?AnimportantvariableinmeasuringthemacroeconomyItisameasureofthecostoflivinginaneconomyatonepointintime.Changesinthegeneralpricelevelonayear-by-yearbasisisameasureoftherateofinflation.TheGeneralPriceLevelandPriceIndicesTomeasurethecostoflivinginaneconomy,economistsputtogetherapriceindex.Thisisameasureofthechangeinpriceofconsumergoods.IntheUK,itwascalledtheRetailPriceIndex,(RPI)Now,theUKGovernmentusestheConsumerPriceIndex,(CPI)TheGeneralPriceLevelandPriceIndicesTheRetailPricesIndexinvolvesthreestagestocompiletheindex;Asurveyofwhatfamiliesbuyandhowmuchtheyspendonparticularitems–whichprovidestheweightsMeasurechangesinpricesofover600itemsMultiplythepercentagechangeinpricebytheweightfromstage1.FromthiswegettheaveragechangeandtheRPI.CPIvs.RPIRPIusesthearithmeticmeanofpricesrisesforgoodsandservices,weightedtoreflecttheconsumptionpatternofUKhouseholds.CPIusesthegeometricmeanwhichallowsforthesubstitutionofcheapergoodsformoreexpensiveoneswhenrelativepriceschange.CPIvs.RPITheRPI(Retailpriceindex)includesmortgageinterestpayments.ThuschangesintheinterestrateseffecttheRPI.Ifinterestratesarecut,itwillreducemortgageinterestpayments.ThustheRPIwillfallbutnottheCPI.TheRPIalsoincludescounciltaxandsomeotherhousingcostsnotincludedinCPITheCPIincludessomefinancialservicesnotincludedintheRPITheCPIisbasedonawidersampleofthepopulationforworkingoutweights.CPIvs.RPITheRPIistypicallylargerthantheCPI,butwhichismoreaccurate?Thereismuchdebatebecause,intheUK,publicpensionsandotherstatebenefitsarelinkedtoCPInow,whichmeanstheyareincreasedeveryyearbyaloweramountthanundertheRPI.CPITheCPIcalculatestheaveragepriceincreaseasapercentageforabasketof600differentgoodsandservices.Aroundthemiddleofeachmonthitcollectsinformationonpricesofthesecommoditiesfrom120,000differentretailingoutlets.CPISide-effectsofCPIThebasketofgoodsandserviceschosenreflectschangesinsociety'sbuyinghabits.Forexample,on23March2009,roséwineandtakeawaychickenwereaddedtothebasket,whereasvolumebottledciderandboxesofwinewereremoved.Also,organisationsmayjustifypricerisessayingtheyare"belowtherateofinflation”.InflationprojectionGDPGrowthprojectionPriceIndicesTheUK’spriceindexisquitesophisticated,butallcountriesthatmeasureinflationwillusethisformulaasabase:CostofLivingIndex=thesumofWeightxPrice(year1)WeightxPrice(year0)X100Where,W=weightofiteminfamilyexpenditure,P=priceoftheitem,n=totalnumberofitemsintheindex.ExampleExamQuestionTheaverageconsumerdivideshisexpenditurebetweenfood,modationandclothingintheratio5:3:2.Duringthecourseofayear,thepriceoffoodrisesby10%,thepriceofmodationremainsconstantandthepriceofclothingfallsby5%.Assumingthattheweightsofapriceindexreflecttheexpenditureoftheaverageconsumer,whatistheincreaseintheindexovertheyear?A.2.5% B.4% C.5% D.6%INFLATIONWhatisinflation?

Inflationisbestdefinedasasustainedincreaseinthegeneralpricelevel

orafallinthepurchasingpowerorvalueofmoney.INFLATIONWhatisinflationinChina?6.1%Whatdoesthismean?Thisistheaverageincrease

inarangeofpricesonconsumergoodsandservicesinChina.Normally,productsareweightedaccordingtoimportance,butisthecurrentmeasureaccurate?

InflationinChinaInflationinChinaChina'sconsumerpricesrose6.1percent,downfromAugust's6.2percentbutwellabovethegovernment's4percenttargetfortheyear.FoodpriceinflationheldsteadyatAugust'slevelof13.4percent.Stubbornlyhighinflationhaspersisteddespitegovernmentmovestoreininsoaringfoodandhousingprices,whichofficialsfearcouldcausesocialunrestascitizensgrowangryathighercosts.Septemberpricerisesweredrivenbya43.5percentjumpinthepriceofpork,a14.2percentincreaseforeggsand11.9percentforgrain.ThereareseveralvariationsoninflationDeflationiswhenthegenerallevelofpricesisfalling.Thisistheoppositeofinflation.Hyperinflationisunusuallyrapidinflation.Inextremecases,thiscanleadtothebreakdownofanation'smonetarysystem.OneofthemostnotableexamplesofhyperinflationoccurredinGermanyin1923,whenpricesrose2,500%inonemonth!Stagflationisthecombinationofhighunemploymentandeconomicstagnationwithinflation.Thishappenedinindustrializedcountriesduringthe1970s,whenabadeconomywascombinedwithOPECraisingoilprices.ThereareseveralvariationsoninflationExcessiveeconomicgrowthcaninfactbeverydetrimental.Atoneextreme,aneconomythatisgrowingtoofastcanexperiencehyperinflation,resultingintheproblemswementionedearlier;Attheotherextreme,aneconomywithnoinflationhasessentiallystagnated;Therightlevelofeconomicgrowth,andthusinflation,issomewhereinthemiddle;It'sacountriescentralbanksjobtomaintainthatdelicatebalance;Atightening,orrateincrease,attemptstoheadofffutureinflation;Aneasing,orratedecrease,aimstospuroneconomicgrowth.INFLATIONThegreatestfallsinthevalueofmoneycameduringthemid-late1970sandagaininthelate1980swhentherewasaccelerationintherateofinflationintheUK.Incontrast,thelastfifteenyearshaveseenmuchlowerratesofinflation–andasaresult,moneyhasheldvaluebetter.ThenextchartshowstheUKconsumerpriceindexsince1970.INFLATIONTherateofinflationismeasuredbytheannualpercentagechangeinthelevelofconsumerprices.TheBritishGovernmenthassetaninflationtargetof2%usingtheconsumerpriceindex(CPI).ItisthejoboftheBankofEnglandtosetinterestratessothatADiscontrolledandtheinflationtargetisreached.SincetheBankofEnglandwasmadeindependent,inflationhasstayedcomfortablywithintargetrange.IndeedBritainhasoneofthelowestratesofinflationinsidetheEU.INFLATIONThevalueofmoneyreferstotheamountofgoodsandservices£1canbuyandisinverselyproportionatetotherateofinflation.Inflationreducesthevalueofmoney.Whenpricesareincreasing,thenthevalueofmoneyisfalling.DEFLATIONPricedeflationiswhentherateofinflationesnegative.i.e.thegeneralpricelevelisfallingandthevalueofmoneyisincreasing.Somecountrieshaveexperienceddeflationinrecentyears–goodexamplesincludeJapanandChina.InJapan,therootcauseofdeflationwassloweconomicgrowthandahighlevelofsparecapacityinmanyindustriesthatwasdrivingpriceslower.

InChina,economicgrowthhasbeenrapid–butthehugeamountofcapitalinvestmentandrisingproductivityhasledtoeconomiesofscalebeingexploitedandafallinproductioncosts,BUTNOWCHANGINGDEFLATIONTherehasbeensomepricedeflationintheUKeconomy–notforthewholeeconomy–butforitemssuchasclothing(wheremanypricesofclothingonthehighstreethavebeendrivenlowerbycheaperimports);audio-visualequipment,computersandmanyotherhouseholdgoods.TheeffectsoftechnologicalchangeinincreasingsupplyareimportantwhenexplainingdeflationinsomeUKmarkets.Rapidadvancesintechnologyhelptoexplainforexamplethesharpfallinthepricesofstateofartdigitalcamerasandtelevisions,whichhasmadethedigitalageaccessibletomillionsofconsumers.DEFLATIONDEFLATIONOvertheperiod1996-2003therehasbeena10%riseinthegeneralpricelevel.Butthishidesmajorchangesinaveragepricesfordifferentproducts.Theaveragecostofpurchasingtobaccoproductshasjumpedbynearlysixtypercentwhereasthepricesofclothing,secondhandcarsandcommunicationhavebeenfalling.HYPER-INFLATIONA500billionsbillwithmostzerosintheeconomy’shistory.TheproductofhyperinflationinYugoslavia1993Hyperinflationisextremelyrare.Whenhyperinflationoccurs,thevalueofmoneyesworthlessandpeopleloseallconfidenceinmoneybothasastoreofvalueandalsoasamediumofexchange.Oftendrasticactionisrequiredtostabilizeaneconomysufferingfromhighandvolatileinflation–andthisleadstopoliticalandsocialinstability.TheInternationalMonetaryFundisoftenbroughtintotheprocessofimplementingeconomicreformstoreduceinflationandachievegreaterfinancialstability.DegreesofInflation<5Mildinflation;canaidcompetitiveness5–9;Mild,butmustbekeptundercontrol10–19;Pressurebuilds,wagedemandsincrease,strictpoliciesrequiredtosolveproblem20–50;Seriousproblem;breakdowninconfidencelikely>50Beginningofhyperinflationandmoneylosesvalueandfunction;currencymaybeabandonedHYPER-INFLATIONRecentexamplesincludeYugoslaviaArgentina,Brazil,GeorgiaandTurkey(whereinflationreached70%in1999).TheclassicexampleofhyperinflationwasofcoursetherampantinflationinWeimarGermanybetween1921and1923.ThecurrenthyperinflationinZimbabwe(over7,000%permonth)isagoodexampleofthehavocthatcanbecausedwhenpriceinflationspiralsoutofcontrol.CausesofInflation“Inflationisalwaysandeverywhereamonetaryphenomenon”.MiltonFriedmanMiltonFriedmanwasaMoneteristeconomistatChicagoUniversityHeispartoftheNeo-classicalschoolofeconomistswhobelieveinsmallgovernmentinterventionandtheefficiencyofmarkets.CausesofInflationHisstatementmeansthatinflationiscausedonlybyanincreaseinthemoneysupplyrelativetooutputintheeconomy.Thismakessomesenseifyouthinkaboutwhatwouldhappeninasimpleeconomywithafixedamountofoutputandafixedamountofmoney.Let’sworkthroughanexampleCausesofInflationMoneteristsmakeuseoftheQuantityTheoryofMoneywhichisbasedonthefollowingequation:MV=PTMistheMoneysupply,Visthevelocityofcirculationofmoney,PisthepricelevelandTisthethelevelofoutput,(valueoftransactions)intheeconomy.Themaincausesofinflation

Inflationcancomefromseveralsources:Internaldomesticeconomy:Majorutilitypricesi.e.electricity,gasandwater;Domesticfoodprices;Increasedgovernmenttaxes,anincreaseintheVATwouldalsobeacauseofincreaseddomesticinflationforexample,becauseitwillincreaseafirm’sproductioncosts.;Anincreaseonthecostoflabourbecauseitwillalsoincreaseafirm’sproductioncosts.Themaincausesofinflation

Inflationcancomefromseveralsources:Externalsources:Ariseinthepriceofcrudeoilorotherimportedcommodities,foodstuffsandbeverages;Fluctuationsintheexchangerate–forexampleafallinthevalueofsterlingmightcausehigherimportprices–whichfeedsthroughdirectlyintotheconsumerpriceindex;Wemakeasimpledistinctionbetweendemandpullandcostpushinflation.Demand-PullInflationDemand-PullInflationiscausedbycontinuingrisesinaggregatedemand.Asaggregatedemandcontinuestorise,(ADcurveshiftstotheright),firmswillrespondbyraisingpricesandincreasingoutput.Raisingpriceswilldependonhowmuchcostsincreaseasoutputincreases.Thisdependsonhowmuchslackthereisintheeconomy–moreslackmeansfirmsarex-inefficientandtheyhaveroomtoreachpotentialoutput.Ifthereislittleslack,firmscanonlyraisepriceandtheSupplycurvewillbeinelastic.Demand-pullinflationDemand-pullinflationislikelywhenthereisfullemploymentofresourcesandaggregatedemandisincreasingatatimewhenSRASisinelastic:ThereisalargeoutwardshiftinAD;Thistakestheequilibriumlevelofnationaloutputbeyondfull-capacitynationale(Yfc)creatingapositiveoutputgap;Thiswouldthenputsupwardpressureonwageandrawmaterialcosts–leadingtheSRAScurvetoshiftinwardandcausingrealoutputandestocontractbacktowardsYfc(thelongrunequilibriumfortheeconomy)butnowwithahighergeneralpricelevel(i.e.inflation).Themaincausesofdemand-pullinflation

DemandpullinflationislargelytheresultofthelevelofADbeingallowedtogrowtoofastcomparedtowhatthesupply-sidecapacitycanmeet;Theresultisexcessdemandforgoodsandservicesandpressureonbusinessestoraisepricesinordertoincreasetheirprofitmargins.Themaincausesofdemand-pullinflation

Possiblecausesofdemand-pullinflationinclude:AdepreciationoftheexchangeratewhichincreasesthepriceofimportsandreducestheforeignpriceofUKexports.

Ifconsumersbuyfewerimports,whileexportsgrow,ADinwillrise–andtheremaybeamultipliereffectonthelevelofdemandandoutput;2. Higherdemandfromafiscalstimuluse.g.viaareductionindirectorindirecttaxationorhighergovernmentspending.

Ifdirecttaxesarereduced,consumerswillhavemoredisposableecausingdemandtorise.HighergovernmentspendingandincreasedgovernmentborrowingfeedsthroughdirectlyintoextrademandinthecircularflowThemaincausesofdemand-pullinflation

3. Monetarystimulustotheeconomy:Afallininterestratesmaystimulatetoomuchdemand–forexampleinraisingdemandforloansorincausingasharpriseinhousepriceinflation;4. Fastereconomicgrowthinothercountries–providingaboosttoUKexportsoverseas.ExportsalesprovideanextraflowofeandspendingintotheUKcircularflow–sowhatishappeningtotheeconomiccyclesofothercountriesdefinitelyaffectstheUK

Cost-pushinflation

Cost-pushinflationcanbeillustratedbyaninwardshiftoftheshortrunaggregatesupplycurve.ThefallinSRAScausesacontractionofnationaloutputtogetherwithariseinthelevelofprices:ThemaincausesofCost-pushinflation

Cost-pushinflationoccurswhenfirmsrespondtorisingcosts,byincreasingpricestoprotecttheirprofitmargins.Therearemanyreasonswhycostsmightrise:Componentcosts:e.g.anincreaseinthepricesofrawmaterialsandothercomponentsusedintheproductionprocessesofdifferentindustries.Thismightbebecauseofariseinworldcommoditypricessuchasoil,copperandagriculturalproductsusedinfoodprocessing;ThemaincausesofCost-pushinflation

2.Risinglabourcosts-causedbywageincreases,whicharegreaterthanimprovementsinproductivity.Wagecostsoftenrisewhenunemploymentislow(skilledworkersescarceandthiscandrivepaylevelshigher)andalsowhenpeopleexpecthigherinflationsotheybidforhigherpayclaimsinordertoprotecttheirreales.Expectationsofinflationareimportantinshapingwhatactuallyhappenstoinflation!3.Higherindirecttaxesimposedbythegovernment–forexampleariseinthespecificdutyonalcoholandcigarettes,anincreaseinfueldutiesorariseinthestandardrateofValueAddedTax.Dependingonthepriceelasticityofdemandandsupplyfortheirproducts,suppliersmaychoosetopassontheburdenofthetaxontoconsumersControllinginflation

ThemostappropriatewaytocontrolinflationintheshorttermisfortheBritishgovernmentandtheBankofEnglandtokeepcontrolofaggregatedemandtoalevelconsistentwithourproductivecapacity;TheconsensusamongeconomistsisthatADisprobablybettercontrolledthroughtheuseofmonetarypolicyratherthananover-relianceonusingfiscalpolicyasaninstrumentofdemand-management;Butinthelongrun,itisthegrowthofacountry’ssupply-sideproductivepotentialthatgivesaneconomytheflexibilitytogrowwithoutsufferingfromaccelerationincostandpriceinflation;Inshort,lowinflationistheresultofacombinationofdemandandsupply-sidefactors.WhyhasinflationremainedlowintheUK&Globallyoverrecentyears?

Lowwageinflationfromthelabourmarket:Wageshavebeengrowingatafairlymodestrateinrecentyearsdespitealargefallinunemployment.ThishasbeenhelpedbyafallinexpectationsofinflationLowglobalinflationanddeflationinsomecountries:Therehasbeenaclearfallintheaveragerateofconsumerpricesinflationamongleadingeconomies,andthisdeclineinglobalinflationhasfilteredthroughtotheUK.Worldinflationhasstayedlowdespitetherecentincreasesinthepricesofmanyoftheworld’sgloballytradedcommodities.TheeffectivenessofmonetarypolicyintheUK:ThesuccessoftheBankofEnglandthroughmonetarypolicyinkeepingaggregatedemandundercontrolthroughinterestratechangesWhyhasinflationremainedlowintheUK&Globallyoverrecentyears?

4.Increasedcompetition:Manymarketshaveemorecontestableinthelastdecadeandthisextracompetitionhasplacedadisciplineonbusinessestocontroltheircosts,reduceprofitmarginsandseekimprovementsinefficiency.ManyUKbusinessesfaceseverepressurefromforeigncompetitionastheprocessofglobalisationcontinues5.Thestrengthoftheexchangerate:TherecentstrengthofthepoundhasloweredthecostofimportedproductsandalsosqueezesdemandforUKexporters6.Informationtechnologyeffects:Therapidexpansionofinformationandcommunicationtechnologyhashelpedtoreducecostsandhasmadepricesmoretransparentforconsumers–mercehascontributedtofallingpricesinmanymarketsCostsofInflationInflationisn'tnecessarilybad;Inflationaffectsdifferentpeopleindifferentways;Italsodependsonwhetherinflationisanticipatedorunanticipated;Iftheinflationisanticipatedwecancompensate,forexample,bankscanvarytheir

interestratesandworkerscannegotiatecontractsthatincludeautomaticwagehikesasthepricelevelgoesup.CostsofInflationProblemsarisewhenthereisunanticipatedinflation:Creditorsloseanddebtorsgainifthelenderdoesnotanticipateinflationcorrectly.Forthosewhoborrow,thisissimilartogettinganinterest-freeloan.Uncertaintyaboutwhatwillhappennextmakescorporationsandconsumerslesslikelytospend.Thishurtseconomicoutputinthelongrun.Peoplelivingoffae,suchasretirees,seeadeclineintheirpurchasingpowerand,consequently,theirstandardofliving.Theentireeconomymustabsorbrepricingcosts("menucosts")aspricelists,labels,menusandmorehavetobeupdated.Iftheinflationrateisgreaterthanthatofothercountries,domesticproductselesscompetitive.

TheMainCostsofInflation

ImpactofInflationonSavers:Inflationleadstoariseinthegeneralpricelevelsothatmoneylosesitsvalue.Wheninflationishigh,peoplemayloseconfidenceinmoneyastherealvalueofsavingsisseverelyreduced.Saverswillloseoutifnominalinterestratesarelowerthaninflation–leadingtonegativerealinterestrates.Forexampleasavermightreceivea3%nominalrateofinterestonhis/herdepositaccount,butiftheannualrateofinflationis5%,thenth