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What Were The Characteristics Of Reaganomics Economics Essay

The basis for Reaganomics can be traced back to the late 1960s and 1970s when after two decades of steady growth and very low inflation the US economy suffered from exceptionally high inflation along with a very slow growth rate, a phenomena that became known as Stagflation. The continuously high unemployment rates throughout the 1970s were another feature of stagflation. This was caused by a number of different factors namely the failure of the dominant post-war Keynesian policies to deal with the rising inflation and unemployment which primarily were focused on the demand management side of economics through expansionary fiscal and monetary policies. Furthermore the Keynesian belief that unemployment and inflation were mutually exclusive based on the Phillips Curve led to persistent efforts to promote artificially low levels of unemployment through increasing government spending and establishing price controls which worsened the soaring inflation rates.
In addition to the Keynesians failures to deal with the domestic issues the US economy faced competition from industrial and developed countries such as Britain, France, Germany and Japan for the first time since the end of second world war. The US benefited from massive expansion of its economy during and after the war years whilst other nations suffered from substantial damages to their infrastructures. However by the mid 1960s the European and Japan’s economies had recovered and had developed technologically more advance and productive economies compared to America. During the period 1950 to 1973, fixed capital stock in the United States grew at an annual rate of 2.9% – a rate that would prove impossible to achieve once stagflation dominated the economy. In contrast, Britain, Germany, Japan and France had annual average growth rates in capital stock of 4%, 6.1%, 7.6% and 4.5%, respectively (Marc Eisner , 1995). As well as increased international competition the external shocks to the US economy in the 1970s such as the oil crisis of 1973 where price of oil quadrupled, along with higher commodities prices caused an even greater pressure on price levels.
The economic and social difficulties caused by the combinations of these factors led to a major demand for a shift in economic policies and was the main promise of Ronald Reagan’s 1980 election campaign. In February 1981 the new administration revealed its Program for Economic Recovery. This program was based on a mixture of different theories namely Monetarism which calls for the Federal Reserve to limit the growth of the money supply in order to curb inflation and Supply Side policies that require a reduction in taxes to increase the incentive to work, save and invest. (John Palmer 1982). These became to be known as Reaganomics and its basic elements were; controlling inflation by restricting the supply of money, reducing income and capital gains marginal tax rates, reducing regulation and intervention in markets and reducing government expenditure whilst increasing defence spending. The objective of Reaganomics was relatively clear, it was designed to increase saving and investments which combined with deregulation and having healthier markets would lead to a higher economic growth. Reducing government expenditure and controlling the supply of money was assumed to not only bring inflation down but also to reduce the ever increasing government deficit.
The success of the program largely depended on the success of all of its individual elements. The administration believed by restricting the supply of money, the rate of increase of total spending in the economy, nominal GNP would go down and this was a necessary condition for reducing inflation. In order to curb inflation and spending whilst reducing unemployment at the same time there had to be a degree of control over inflationary expectations and a significant rise in productivity to counter the rise of labour costs. The administration’s commitment to monetary control and balancing the federal budget would help to correct the inflationary expectations whilst the increase in productivity would be achieved by the increase of nation’s savings to encourage private and productivity-raising investments as a result of tax cuts and elimination of government deficit. Furthermore the stimulus to productivity and production resulting from such tax cuts would increase the national income which in turn would offset the revenue loss that lower tax rates cause. (Herbert Stein, 1988)
Thus the failure of any individual element of the program would lead to the collapse of the whole program or at the very least significantly reduce its desired effect on the economy.
Restoring price stability by curbing inflation therefore was one of the major priorities of the Economic Recovery Program. This was based on the monetarist view that a steady reduction in money supply growth whilst managing inflationary expectations effectively would be the best way to reduce inflation. The Reagan administration hoped to achieved this without causing a painful transition period of high unemployment and loss of output therefore it was essential for businesses, workers and investors to fully have confidence in government’s ability to succeed and thus react accordingly. Although neo-Keynesians argued monetary restrain would almost certainly lead to a further increase in unemployment and would push the economy into a recession as prices and wages are sticky or sluggish and relatively unresponsive to monetary policies in the short run. (32) However according to the Rational Expectations school of thought individuals would realise and anticipate the benefits of a well advertised monetary policy and would be willing to accept lower wages and prices for their goods and services and hence would avoid any unpleasant consequence of a drop in output levels. (31).
The administration believed the war against inflation would be relatively short and pain free. Thus the Federal Reserve under the leadership of Paul Volcker attempted to decrease inflation rates by controlling the adjusted monetary base which is the total amount of currency in circulation or in the commercial banks deposits in the Federal Reserve. This was done by controlling the reserves supplies to the banking system through the Federal Reserve’s purchases and sales of government securities and the amount it required banks to maintain in reserves against their deposits. The Federal Reserve also controlled -albeit to a lesser extent- the money supply especially the narrower form of money (i.e. M1) such as currency and checkable deposits. (R.E)
As a consequence the inflation fell from its double digits peak in 1980 to below 4% by the summer of 1982, however this success in curbing the inflation had a devastating impact on the economy. The tight credit control led to further increases in interest rates as investment fell. The gross national product fell by more than 2.5% whilst unemployment rates peaked at 11% in 1982. It seemed clear Reagan’s ambitious plans to reduce inflation and maintain a healthy economic growth simultaneously had failed. (State Blue book). Although by July 1982 the Federal Reserve eased up its tight grip on the money supply and the expansionary fiscal policies by the administration led to the recovery from the recession. The economy grew by 6.8% by 1984 with unemployment figures dropping to 7.4% first and then to 5.4% in 1988 whilst the GNP also increased, standing at 4.5%. Inflation remained low for the remainder of Reagan’s administration dropping to as low as 1.1% in 1986 before standing at around 4% towards the end of the decade.
However despite this positive economic figures it’s important to take into account the external factors that created a far more favourable economic environment throughout the 1980s compared to the previous decade. The main cause of inflation in the late 1970s was the high food and energy prices partly caused by the oil crisis of the 1973 and the Energy crisis of 1979 (in the wake of the Iranian revolution) however as a result of the sharp decrease in demand for oil in developed countries and the virtual collapse of OPEC, the oil prices decreased by two third between 1980 and 1985. (state source). Moreover expansionary fiscal policies such as federal subsidies for farmers and an inflated dollar despite having a negative impact on the budget deficit, contributed to price stabilisation as food prices fall and imports became cheaper. “the collapse of OPEC, food surpluses, the debt inflated dollar and measurement corrections in the role of home ownership sots in calculating the Consumer Price Index accounted for 52.3% of the reduction in inflation with the remainder attributable to the rescission induced unemployment rates”. (end with a conclusive sentence?).
Balancing the budget was another top priority of the Reagan’s administration however throughout his two term as president the deficit continued to grow as a result of the loss in government revenue caused by the Economy Recovery Tax Act of 1981 and the largest peace time defence spending since the Second World War. (Midterm report). The deficit that was under 35% of the GDP in 1980 had increased to over 55% of the GDP by the end of the decade. The idea that having an unbalanced budget would have damaging consequences for the economy was another monetarist element of the Reagan’s administration. This was a clear rejection of the Keynesian view that stated the government could stimulate the economy by increasing its deficit which in turn allows it to increase expenditure and investment in the private sector resulting in an increase in aggregate demand, total output and employment levels as long as the economy isn’t performing at its maximum capacity hence outweighing the costs of financing the deficit. In contrast the monetarist insisted on the need for a balanced budget claiming that even though government on one hand could give money to people through higher expenditure it would have to take an equal or higher amount back to finance its debts.
The administration therefore attempted to decrease the deficit and eventually balance the budget by as early as 1984.It intended to do this by reducing government expenditure as a percentage of the GDP from 23% to 19.5%. (industrial book) In its Program for Economic Recovery it introduced substantial cuts in state aid programs such as Medicaid, food and nutrition programs, extended unemployment benefits and housing assistance whilst reducing subsidies for new energy technologies, public service employment and student aids. (Mid term). Although the effectiveness of such cuts in expenditure and the target of balancing the budget by 1984 turned out to be extremely optimist and unrealistic. The administration failed to achieve its objective mainly because of its inconsistent policies. For instance whilst trying to reduce the deficit it introduced the Economic Recovery Tax Act in the summer of 1981 reducing marginal income tax rates by 25% causing a major loss of revenue for the government. The administration argued such revenue loss would be offset by a rise in savings, investments and output levels however as the economy entered a recession in 1981 – mainly due to its tight monetary policy – the deficit continued to rise. Furthermore the government increased defence spending steadily throughout the decade, in 1982 the defence budget rose by $7.3b and later by $33.1 in 1986. (R.E).
The government’s failure to reduce its deficit had severe consequences for the economy especially during the 81-82 recession. The major problem with the deficit was the financial cost of financing the debt itself, this was estimated to be close to $184.2b or 14.7% of the budget in 1990. (s.bb) The administration attempted to raise funds by selling securities such as government bounds which due to their secure nature and high rates of return attracted investors and capital. However this had a negative knock on effect on the economy too since by extracting billions of dollars per year from the national saving pool which had already been in decline since the 1950s (shrinking to 2.4% of GDP in 1988 from 7.8% in the 1970s) the government took away scarce capital from the private sector leading to the crowding out phenomena. This is when the government and the private sector compete for the same limited capital available in the market hence causing a reduction in the expansion of businesses and firms. This loss of capital further translates into higher interest rates and lower levels of investment which in turn leads to a loss of competitiveness and reduction in the output levels, subsequently increasing unemployment and pushing the economy deeper into the recession.
Overall it had quickly become apparent that the administration’s goal of balancing the budget was clearly unrealistic. Despite it’s desire to reduce the deficit the introduction of tax reductions and increasing the defence spending more than offset any gains made from the cutbacks in the federal expenditure. The centrepiece of Reagan’s tax cuts was the Economic Recovery Act signed into law in 1981.

The Causes And Effects Of Inflation Economics Essay

In practice, the evolution of inflation is measured by the change in the Consumer Price Index (CPI). To understand the phenomenon of inflation, one must distinguish between generalized price increases that occur once and forever, those price increases that are persistent over time. Within the latter can also make a distinction regarding the degree of magnification. There are countries where inflation is controlled under 10% annual average inflation that others do not exceed 20% annually and countries in which price growth has exceeded 100% annually. When the price variation reaches 50% a month is called hyperinflation.
INTRODUCTION Today, we live in a world of great changes bring us closer to an unpredictable future.
In this context, a crucial factor models for the survival of nations is the economy and it is precisely here where the largest anomalies are occurring in human history.
Everyday talk is already concern about the phenomena that threaten not only our own future but that of all the families and the country itself.
In this paper we address precisely for inflation, this issue affects us and that both frightens and that despite efforts at all levels to support the advancement of science, it is impossible to control and combat.
So let us develop this short survey of inflation from its conceptual meaning, its causes and effects, to reach some conclusions to try to bring solutions and recommendations.
Concept
Inflation is defined as a continuous process of raising prices, or whatever it is, a continued decline in value of money. Money loses value when the can not buy the same quantity of goods than before.
2. Lessons From Inflation
Overheating .- It is said that there is overheating in the economy when there is a slight increase in prices.
.- Rampant inflation implies the existence of inflation rates between 4% and 6%.
Accelerated inflation .- inflation is reaching almost 10 100 annually.
.- Hyperinflation results in loss of control of prices by the economic authorities of the country. In some cases, have come to identify price increases of up to three digits (over 1,000 100anual) Occurs when a currency (usually dollar) or a range of goods (cigarettes, drinks …) just to replace the money as official exchange pattern.
Reasons for Inflation
Inflation can be caused by:
.- That demand inflation which is caused by an excess demand for supply rigidities, has no answer other than raising prices.
.- Cost inflation is inflation that is due to increased costs of inputs and the different factors of production, ie, motivated by the increased cost of labor, interest rates, prices soil, energy, raw materials, etc.
3. Causes of Inflation
Inflationary processes may be caused by the excessive creation of money by the monetary authorities of the country. In these cases eldinero grows faster than goods and services provided by the economy, causing increases in prices. This excessive money creation is often motivated, in turn, by the need for the state to finance its deficits.
The economic agents’ expectations about how prices are likely to evolve in the future. This is very important because if for example, operators can expect prices to increase in the short to medium term, seek to quickly incorporate this to the salaries and other payments set by contract. This would cause significant inflationary pressures, which if put into practice would lead to a price increase more than expected.
The credibility you might have the government’s economic policy is another important factor that can lead to inflation. If traders have no confidence in government economic policy, in theory aimed at reducing prices, their actions will aim to raise wages and prices. This attitude would ruin the government’s restrictive policies.
The long-term wage agreements can be a double-edged sword, because continued negotiating wage agreements in a context of instability can be harmful, the fact is that long-term agreements, three years or more can prevent the on inflation control more effective.
Disturbances that the supply side are also common causes of inflationary pressures. The greater or lesser strength, the evolution of oil prices and raw materials are factors that can significantly affect the prices of the economies of a country, especially in those countries more dependent on inputs from abroad as the case of the Spanish economy.
Cost Of Inflation
The costs of inflation from the vast majority of the unsuitability of the economy to inflationary situation. For example, one of the most important cost of inflation is the increase in taxes if no tax brackets to adapt to higher prices.
When there is inflation and the taxpayers see their salaries increased to the extent that the government does not adjust the tax table in this price growth, the amount of tax will be higher. In these cases, operators must pay a higher tax number, not by a higher level of income, but simply because the price increase.
Another cost of inflation is causing the redistribution of income. Inflation hurts traditionally the lender (creditor), beneficiandoal borrower (debtor). Thus, inflationary situation, people have to deal with a loan will be repaid, in real terms, an amount less than the original. In a family situation, savers will see the actual balance of their bank deposits will lose value as prices rise. Only in those in which interest rates adjust to inflation may prevent these losses, both for lenders and for savers. Thus, it appears that the important thing is to keep real interest rates, both nominal no.
A cost related to the above is the uncertainty created by inflation. This uncertainty makes traders, given the risk that their investments worth less, to increase interest rates, which would negatively affect investment and hence economic growth in the country.
Finally, if the rate of price growth in a country far exceeds that of countries with which it competes in international markets, dichopaís will be less competitive. Obviously the higher the price, the more difficult than domestic products may be comercializadosen third countries, which requires, in this way, governments maintain a growth rate similar price if not less, to the d elos suentorno countries. Keeping all factors constant, an increase of losprecios higher than our competitors will reduce our competitiveness.
Bad Is Inflation?
Economic theory tells us that inflation, especially unexpected, leads to uncertainty about future prices, which affects decisions on spending, saving and investment, resulting in poor allocation of resources and thus hindering the growth economic.
However in Britain, in the early 50’s, presented a study, now known as the Phillips curve, which suggests that the higher the inflation the lower the unemployment rate (and, conversely, it possible to lower the inflation rate to incur a greater number of unemployed) question, therefore, anti-inflation measures proposed by governments.
For its part, in 1990, Robert Barro, a prominent Harvard professor and member of the Bank of England, published a comprehensive study linking inflation and the growth of more than 100 countries, rich and poor, between 1960 and 1990, and reached the following conclusions: On one side is indicative of the economic theory, and determined that a rising inflation reduces economic growth. However this reduction is very small, between 0.02 and 0.03 percent for every point rise in inflation, which is especially disastrous for a country but, given that reducing inflation is costly in itself because it carries a significant loss, at least temporarily, production and jobs, questioned whether the company was not paying too high a social cost as a priority to reduce inflation.
Although this inflation is often very unpopular with consumers do not like having to pay more for a product from a month to month, even though their income (the earnings) have been increased by the same amount, and The government has become the containment of inflation in one of the most important of his political-economic agenda.
Finally note that in developed countries, inflation is being contained thanks to technological advances, the declining influence of unions, privatization and the growing national and international competition, which are driving down the cost of raw materials and energy products and, therefore, the final price of goods and services produced, rather than a successful anti-inflationary policy of the governments involved.
The risk is confusing monetary manifestations, such as inflation, the real causes of the contradictions of the economic system. No doubt the economic and general agents propose solutions involving the manipulation of variables because monetary policy can control the monetary transmission mechanism in the short run and demonstrate the progress of objectives.
Perhaps it was more practical to place the mirror inflation not as money but focus on actual case mix reflects the inflationary phenomenon: the production system bottlenecks that distort the balance between supply and demand of goods and services, price management interested by concerted economic groups, the tight distribution of income among groups of beneficiaries, etc.
In this sense, is yet to establish the true social cost and quality compliance with certain goals of convergence in the complex process of monetary union and this gap is crucial to anticipate a cost-benefit calculation on the regional impacts, sectoral, corporate competitive. , With full monetary union. “
CPI
Measure of inflation we use a price index, by a figure expresses the average growth of assets during a period of time. Therefore the Spanish CPI is a statistical measure that shows the evolution of prices of all goods and services consumed by the population living in family households in Spain. Consumption means the actual population spending on goods and services excluding both the operations of any charges relating to the self, self, imputed rent subsidized consumption, health or education, and homeownership.
Thus the national statistical institute draws up a list of items representative of all goods and services consumption, which is known as a basket of goods. Taking this basket in the base year, take the price of goods at the time of preparing the index. Getting the cost of the same basket of goods in two different dates, calculate the ratio of the two resulting in the price index.
For the preparation of the basket of goods in the Spanish case are selected a total of 471 items classified into 8 groups, with each item weighted by the expenditure made in that article with respect to total spending by households. The base year for determining the CPI was 1,992.
In the media spreads the rate of inflation, which is most often used in measuring the economic and price growth in the last twelve months.
How is the CPI?
Are collected and processed about 150,000 different prices of 471 different items in 29,000 establishments in 130 municipalities in Spain, of which 50 are provincial capitals, 78 non-capital cities, plus Ceuta and Melilla.
The price collection was carried out between 1 and 22 of each month, inclusive. The selected establishments always visit the same day of the month, so that the change reflected by the index corresponds perfectly to a monthly change.
Establishments must be of average or most common type in the locality, the higher volume of sales or customer traffic and provide assurance of continuity in the selected articles on them.
The sample of remains fixed over time, only replacing establishments close, change of activity, lose representation in what made them consumer concerns, and those in the market to stop definitively the article which took the price.
Each establishment is visited once a month with the exception of those who report the price of so-called quarterly collection items – audio equipment, electronics, furniture, repair services and in general all those that do not pose too many variations prices over time, “for which price collection is done at each facility every three months. On the contrary, as the perishable goods are subject to significant fluctuations in prices, these are taken three times during the month in each of the selected establishments in the provincial capitals, but only once in the establishments of other municipalities.
Prices listed are the actual retail with cash. Not taken into account for defective goods, settlements, balances, discounts or offers, unless these are made across the board in all establishments in the town and have a minimum of two months.
Indices are calculated for Spain’s seventeen autonomous communities, the fifty provinces, Ceuta, Melilla, and for the group formed by these two cities.
All systems based on calculation of this index in the Laspeyres formula, which is a complex index that expresses a single figure, the variation of the components that make up over time, weighting each according to their importance.
How do we affect the CPI?
Often used as a measure of inflation. Noting, in this way, the loss of purchasing power experienced by operators for the rise in prices of goods and services for consumption.
Real estate leasing. According to the Tenancies Act, during the first five-year contract income can only be updated based on the CPI to rise last year.
Negotiating salary and pensions. The government usually updates the minimum wage, pensions, salaries of civil servants, raising them in so far as setting its growth forecasts for inflation. For their part, wage increases in collective bargaining, are made according to the rate of inflation based on CPI. In some collective agreements there is a safeguard clause, which allows for greater wage increases, if inflation is higher than expected.
Income statement. The Ministry of Finance each year tends to deflate the income statement as inflation has risen. This means increasing the deductions and tax amounts for each instalment, as taxpayers, to raise prices, they need more money (in monetary terms) to buy the same things.
In finance. When inflation rises interest rates rise, therefore, those who have a mortgage with a variable rate, will increase what you have to pay to your bank each month. Consumers demand less credit to buy things and less credit will also ask companies for investment. As a result, companies sell less and lower their profits and, at the same time, savers put his money in fixed income, due to the high interest they receive for their money and, therefore, the stock end down. If inflation is low, the opposite happens.
Conclusions and recommendations
Inflation is a phenomenon closely linked to the economic policy of developed countries and institutions that control and regulate the global economy.
It is clear that within the national economy and EFFECTIVENESS capacity of successive governments to manage the economy through laws and decisions, is the key to the stability and welfare of the inhabitants.
In the specific case of Peru, there is great expectation in its economic recovery from the rational exploitation of the main productive sectors: Mining, fishing and tourism.
Recommendations
Peru needs to establish clearly the scope of its economic Polittico and where possible, improve its relationship with investors and creditors of the developed countries.
The government and business, a unified, should strive to boost production by industrial and commercial development. By creating jobs and promoting exports, will gradually improve our current situation.
One necessary step should be the regulation of imports, after investigation, to prevent excessive output current currency.
All the world pays a greater or lesser degree have experienced inflationary processes. This economics produces social costs high, enough to demonstrate the importance of this issue. A inflation is defined as the continued growth and general price of goods and services on a economy, and is measured behavioural showing indices Consumer Price (CPI). Other less precise definitions explain how the continued upward movement of the general price level or diminution the purchasing power of money. Inflation level exceeding 50% per month is defined by Philip Cagan as a “hyper inflation.” It should be noted that there is no complete and well formed theory on formation prices. This is due in part to decisions on price fixation not rely solely on the observation verifiable variables, but Also do the behaviour of individuals and the expectations or assumptions that each of these is made on demand.
Causes inflation
About economy by an inflation levels may have had certain and varied causes. Not even all economists agree among its reasons and recipes, but yeah it sealer agree on a group of them as important mass. First economics affairs experts point out as an important cause in the development of inflation that the pays income level increases, as this motivates people to spend money mass prices rise, because the law supply and demand. This law works very there buyers, while producers manufacture mass to meet that demand and sales, driven by high consumer demand, rising prices of products. Another major reason that economists cite is the fact that some factors necessary for production increase their price, for example, raise the gasoline or requiring workers to increase wages, because the employer these increases in the prices incremented. And another factor mayoral including experts is to increase corporate profits. That is, employers want to increase their share of benefits, for which, if there is good demand may increase prices and therefore earn more without reducing sales.
It should be clarified that the cases are considered separately, but there is interdependence. The most known is called inflation excess demand. This occurs when the overall demand for goods and services exceeds the global supply of them. And is that with an increase in aggregate demand, either levels of taxation or a redistribution to low-income areas (because they consume more marginal pro pension), generates an excess demand on the ability of the economy producing resulting in increased prices. This is mainly theory feature will cut bibliography Keynesian.
A second cause of inflation is motivated by monetary variables. This takes expression through quantitative theory money assuming fixed product, the purchasing power parity (PPP) and the free movement of capital. It is noted that the high inflation source is in the large and persistent fiscal deficits central bank monetized. If we analyze a model of deficit under floating exchange rate, deficit say that this can be covered by taking, reducing reserves or printing money. Assuming that we can not count the first two options, as often happens when the deficit is persistent over time, is therefore only the third option. By funding the deficit, the Central Bank causes an increase in nominal money supply. Then (given the prices and the rate of interest), families try to convert foreign asset balances unwanted depreciation generating exchange rate and the PPP, concludes in a price increase. In this procedure increased the deficit monetization price is considered as an “inflation tax” and the holders of money lose their purchasing power. Now if we analyze a model of deficit under fixed exchange rate, the process serves similar, with the difference that in principle the government can be financed by reserves until exhaustion, which comes into play or flotation devaluation exchange rate obtaining the same result as above.
A third cause of inflation is motivated by economics costs. In the cost inflation distinguish various types and conditions climatic as, redistribution between employees, employers and public sector, rising input prices (being the important mass of petroleum) or a devaluation for those production processes that use imported inputs . Under a fixed exchange rate (flexible) a devaluation (depreciation) of the currency generated by three inflation different: (1) the prices of imported final goods, (2) the prices of tradable goods domestics, and (3 ) for intermediate goods prices falling on the costs of internal production. These are analyzed and focused on the concept of “pass-through” that measures the percentage to be transferred to prices driven by a devaluation, aiming to know the real depreciation devaluation generated by the nominal. In developing countries is common the presence of so-called inertial inflation, which occurs when periods of high inflation coming note with much sense that agents try to protect the prides of income or capital. Therefore, contracts, leases etc., This indexation subject to nominal values indices published by government agencies. The theory has tried to address this subject from the economist AW analysis Evolution Phillips on wages and unemployment (Phillips curve).
What is inflation
Inflation is the continued growth and general price of goods and services and productive factors in an economy over time. Other definitions explain how the persistent upward movement in the general level of prices and declining purchasing power of money.
Inflation is the continued growth and general price of goods and services and productive factors in an economy over time.
In practice, the evolution of inflation is measured by the change in the Consumer Price Index (CPI). To understand the phenomenon of inflation, one must distinguish between generalized price increases that occur once and forever, those price increases that are persistent over time. Within the latter can also make a distinction regarding the degree of magnification. There are countries where inflation is controlled under 10% annual average inflation that others do not exceed 20% annually and countries in which price growth has exceeded 100% annually. When the price variation reaches 50% a month is called hyperinflation.
Causes of inflation
Inflation, as an economic phenomenon has causes and effects. The definition of its causes is not a simple matter because the general increase in prices often becomes a circular complex mechanism of which is not easy to determine the factors driving the price increase. This difficulty in determining the causes of inflation, has been the driving force behind a number of different test theoretical explanations of the inflationary processes. Explanatory theories generally fall into three categories. On one side are those who consider inflation as an explanation of excess aggregate demand, or demand-pull inflation. On the other hand, are those that aim to aggregate supply as a trigger for inflation, this is what is called cost-push inflation. Finally, there is a group of theorists who understand inflation as the result of social rigidities, this is what is called core inflation.
Fiscal deficits, their financing through the issuance and inflation
The fiscal deficit is a potential trigger an inflationary process. On the one hand, if we start from a position of balance between aggregate supply and aggregate demand, increased government spending without being accompanied by a similar increase in tax revenues, create both an excess of aggregate demand, as increased in the fiscal deficit. This is the evidence the Keynesians and trigger inflation.
The monetarists also assume that is an excess of aggregate demand which turns the inflationary process, but differ in the Keynesian as to the cause that generates this excess demand. Since its inception, is an increase in the money supply through greater availability of liquidity, leading to increased aggregate demand. Therefore, if the State, after having exhausted all sources of private credit, used to be financed through increases in the issuance of currency, it will generate a cash surplus that will result in excess demand and general increase in prices .
When a government carries a heavy debt, each time it becomes more difficult to get proper financing. When credit sources are exhausted and persistent deficits, governments often resort to printing money as a last instrument to finance its expenditure. The issue is not genuine, ie an increase in the supply of money is not accompanied by an increase in the demand for money, generating an increase in prices.
Financing a deficit by issuing different effects depending on whether a system of fixed exchange rate or flexible. As will be seen, countries with chronic budget deficits and high magnitude, would find it extremely difficult to maintain a fixed exchange rate and make the choice to move to floating exchange rate, or at least make frequent adjustments of the parity monetary.
Fiscal deficits, fixed exchange rate
When an economy operating under a fixed exchange rate has exhausted its sources of financing direct loans from the public, internal and external, the only tool you have left to finance the excess of expenditure over income is to borrow from the bank central.
Whenever the government tries to be financed through loans from the central bank will increase the monetary base, but since money balances are constant demand that will generate an excess supply of money. Families become surplus cash balances in foreign assets, pushing the exchange rate devaluation. As the central bank is committed to maintaining the value of domestic currency at a given level, you must change the excess foreign exchange currency. This process will continue until the supply of money to return to its initial level and even to the demand for money balances that remained constant throughout the process.
While the central bank has to hold foreign currency exchange rate, inflation will remain under control given that international prices do not vary and include compliance with the law of one price. Thus, the government can keep the price level to fund their expenses through the issue. But this is a solution that can not be sustained for long, because if the government insists to finance its deficits by creating money, will only deplete the central bank. When residents warn that the country’s central bank may not maintain the value of the currency change faster domestic assets by foreign assets, to guard against the possible loss of value to the future suffer devaluation. Finally, when the central bank reserves have reached their limit, no choice but to let the currency depreciate. The process ends with the abandonment of the fixed exchange rate, whether devaluing and setting a higher value of the exchange rate or allowing the currency to float freely. The collapse of a system of fixed exchange rate when reserves are depleted central bank is called balance of payments crisis.
Fiscal deficits floating exchange rate
When an economy is managed under a system of floating exchange rate before any increase in the money supply the central bank should no longer go out to defend the value of offering foreign currency. If the issue specifically, the value of foreign currency will increase. Since there is a relationship between domestic and foreign prices, formalized in the law of one price or purchasing power parity, the rate of inflation will be equal to the rate of devaluation. In a system like this, there is a direct relationship between the magnitude of the deficit being financed and the rate of inflation. Deficit financing actually comes from the inflation tax.
Effects of inflation on the economy of a country
The effects of inflation are to some extent as it can be expected or unexpected. Whatever form it takes inflation, entails costs and the higher the rate of price changes the higher the costs.
There are costs of holding money, so that operators spend more time discussing what to do with their money balances. The inflationary process involves, for dealers, real costs to update the prices. The steady increase in the general price level has redistributive effects in favor of debtors, in the distributive struggle employees and all those who depend on fixed nominal incomes will reduce their real income. Finally, as has been studied by Olivera-Tanzi, inflation also causes costs to the treasury due to the delay between the time of incurring the expenses and revenue collection.
There are two types of inflation: on the one hand we have what is known in advance and incorporated into the expectations of economic agents, on the other hand, inflation may be unanticipated by económcios agents, which is presented before that individuals have adjusted their expectations.
Early inflation
– The agents try to minimize such losses by reducing their average balances of money.
– Will be assigned most of the wealth to the consumption of durable goods, as a protection against the inflation tax.
– The update process of nominal prices imply real costs associated with expenditures to be made by traders in the demarcation process.
– Inflation may lead to distortions in the tax burden. For example, assuming that the sections of income tax are fixed in nominal terms over time will increase nominal income, and people will move to higher tax brackets, thereby increasing the marginal tax rate. Thus, a person whose pre-tax real income is constant suffer a gradual increase in their tax and consequent loss of disposable income, simply because of inflation. The greater the variation in prices, the greater the costs involved.
– Inflation also involves costs to government because it undermines the value of the taxes it collects. This is because there is a delay between the time it occurs and state spending when taxes are raised to cover these expenses. In many countries, during this time lag, there is no mechanism to maintain the real value of tax liability. This phenomenon is known as the Olivera-Tanzi effect, which can lead to a vicious circle. An increase in the fiscal deficit leads to an increase in inflation, which in turn, reduces tax revenues, lower tax revenues, in turn, further increase the fiscal deficit, and so on.
Unanticipated inflation
The main effects of unanticipated inflation are redistributive. Surprises in inflation rates lead to shifts in income and wealth between different groups of the population. During an inflationary process, borrowers will benefit at the expense of creditors, as inflation erodes real interest rates. Depending on the degree of increase in prices of real interest rates can become negative, which clearly favor ending the subjects who took loans.
In general, all holders of financial assets that have a fixed nominal rate of return will suffer a loss because of increases in the rate of inflation. To avoid the wear suffered these assets against rising prices, indexed instruments have been developed that agree to pay a real interest rate or, put another way, adjust the nominal interest rate paid by an index avoids the loss in value caused by the increase in prices.
The redistributive effects of unexpected inflation are also apparent within the household sector. Mortgaged homeowners will benefit to see that his payments reduced in real terms. Moreover older people remain more nominal balances than younger, which is why an inflationary process redistributes income in favor of younger individuals.
They are also subject to a bid redistributive wage sectors. The price increases undermine the real wages of workers hired. Although employment contracts include clauses setting, the effectiveness of you to avoid the loss of income of workers is reduced because the contracts are reviewed from time to time while the increase in prices is an ongoing process, so adjustments in the contracts only

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