Causes of Inflation in Various Countries and Regions

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Causes of Inflation in

Various Countries and

Regions

By:

OpenStaxCollege

Policymakers of the high-income economies appear to have learned some lessons about fighting inflation First, whatever happens with aggregate supply and aggregate demand

in the short run, monetary policy can be used to prevent inflation from becoming entrenched in the economy in the medium and long term Second, there is no long-run gain to letting inflation become established In fact, allowing inflation to become lasting and persistent poses undesirable risks and tradeoffs When inflation is high, businesses and individuals need to spend time and effort worrying about protecting themselves against inflation, rather than seeking out better ways to serve customers In short, the high-income economies appear to have both a political consensus to hold inflation low and the economic tools to do so

In a number of middle- and low-income economies around the world, inflation is far from a solved problem In the early 2000s, Turkey experienced inflation of more than 50% per year for several years Belarus had inflation of about 100% per year from 2000

to 2001 From 2008 to 2010, Venezuela and Myanmar had inflation rates of 20% to 30% per year Indonesia, Iran, Nigeria, the Russian Federation, and Ukraine all had double-digit inflation for most of the years from 2000 to 2010 Zimbabwe had hyperinflation, with inflation rates that went from more than 100% per year in the mid-2000s to a rate

of several million percent in 2008

In these countries, the problem of very high inflation generally arises from huge budget deficits, which are financed by the government printing its domestic currency This

is a case of “too much money chasing too few goods.” In the case of Zimbabwe, the government covered its widening deficits by printing ever higher currency notes, including a $100 trillion bill By late 2008, the money was nearly worthless, which led Zimbabwe to adopt the U.S dollar, immediately halting their hyperinflation In some countries, the central bank makes loans to politically favored firms, essentially printing money to do so, and this too leads to higher inflation

A number of countries have managed to sustain solid levels of economic growth for sustained periods of time with levels of inflation that would sound high by recent U.S standards, like 10% to 30% per year In such economies, most contracts, wage levels, and interest rates are indexed to inflation Indexing wage contracts and interest rates means that they will increase when inflation increases to retain purchasing power When wages do not rise as price levels rise, this leads to a decline in the real wage rate and a decrease in the standard of living Likewise, interest rates that are not indexed mean that the lenders of money will be paid back in devalued currency and will also lose purchasing power on monies that were lent It is clearly possible—and perhaps sometimes necessary—for a converging economy (the economy of a country that demonstrates the ability to catch up to the technology leaders) to live with a degree

of uncertainty over inflation that would be politically unacceptable in the high-income economies

Concepts and Summary

Most high-income economies have learned that their central banks can control inflation

in the medium and the long term In addition, they have learned that inflation has no long-term benefits but potentially substantial long-term costs if it distracts businesses from focusing on real productivity gains However, smaller economies around the world may face more volatile inflation because their smaller economies can be unsettled by international movements of capital and goods

Self-Check Questions

How does indexing wage contracts to inflation help workers?

Indexing wage contracts means wages rise when prices rise This means what you can buy with your wages, your standard of living, remains the same When wages are not indexed, or rise with inflation, your standard of living falls

Use the AD/AS model to show how increases in government spending can lead to more inflation

An increase in government spending shifts the AD curve to the right, raising both income and price levels

Show, using the AD/AS model, how monetary policy can be used to decrease the price level

A decrease in the money supply will shift the AD curve leftward and reduce income and price levels Banks will have less money to lend Interest rates will increase, affecting consumption and investment, which are both key determinants of aggregate demand

Review Questions

Is inflation likely to be a severe problem for at least some high-income economies in the near future?

Is inflation likely to be a problem for at least some low- and middle-income economies

in the near future?

Critical Thinking Questions

Why are inflationary dangers lower in the high-income economies than in low-income and middle-income economies?

Problems

Retrieve inflation data from The World Bank data base (http://databank.worldbank.org/ data/home.aspx) for India, Spain, and South Africa for 2008–2012 Prepare a chart that compares India, Spain, and South Africa based on the data Describe the key differences between the countries Rank these countries as high-, medium-, and low-income Explain what is surprising or expected about the data