Macroeconomics

BAFB1033

The Inflation: What are the pros and cons of

inflation on the economy?

Semester : SEPTEMBER 2023

Student Name : Muhammad Syahmi Bin Anua

Matric Number : mc230521983

1.0 INTRODUCTION

1.1 The Inflation

In economics, inflation is a general increase of the prices of goods and services in an

economy. This is usually measured using the consumer price index (CPI). When the general
price level rises, each unit of currency buys fewer goods and services; consequently, inflation
corresponds to a reduction in the purchasing power of money. The opposite of CPI inflation is
deflation, a decrease in the general price level of goods and services. The common measure
of inflation is the inflation rate, the annualized percentage change in a general price index. As
prices faced by households do not all increase at the same rate, the consumer price index
(CPI) is often used for this purpose. Inflation is a rise in prices, which can be translated as the
decline of purchasing power over time. The rate at which purchasing power drops can be
reflected in the average price increase of a basket of selected goods and services over some
period of time. The rise in prices, which is often expressed as a percentage, means that a unit
of currency effectively buys less than it did in prior periods. Inflation can be contrasted with
deflation, which occurs when prices decline and purchasing power increases.

Changes in inflation are widely attributed to fluctuations in real demand for goods and
services (also known as demand shocks, including changes in fiscal or monetary policy),
changes in available supplies such as during energy crises (also known as supply shocks) or
changes in inflation expectations, which may be self-fulfilling. Moderate inflation affects
economies in both positive and negative ways. The negative effects would include an
increase in the opportunity cost of holding money, uncertainty over future inflation, which may
discourage investment and savings, and if inflation were rapid enough, shortages of goods as
consumers begin hoarding out of concern that prices will increase in the future. Positive
effects include reducing unemployment due to nominal wage rigidity, allowing the central
bank greater freedom in carrying out monetary policy, encouraging loans and investment
instead of money hoarding, and avoiding the inefficiencies associated with deflation.

Today, most economists favour a low and steady rate of inflation. Low (as opposed to
zero or negative) inflation reduces the probability of economic recessions by enabling the
labor market to adjust more quickly in a downturn and reduces the risk that a liquidity trap
prevents monetary policy from stabilizing the economy, while avoiding the costs associated
with high inflation. The task of keeping the rate of inflation low and stable is usually given to
central banks that control monetary policy, normally through the setting of interest rates and
by carrying out open market operations. While it is easy to measure the price changes of
individual products over time, human needs extend beyond just one or two products.
Individuals need a big and diversified set of products as well as a host of services for living a
comfortable life. They include commodities like food grains, metal, fuel, utilities like electricity
and transportation, and services like healthcare, entertainment, and labor.

Inflation aims to measure the overall impact of price changes for a diversified set of
products and services. It allows for a single value representation of the increase in the price
level of goods and services in an economy over a period of time. Prices rise, which means
that one unit of money buys fewer goods and services. This loss of purchasing power impacts
the cost of living for the common public which ultimately leads to a deceleration in economic
growth. The consensus view among economists is that sustained inflation occurs when a
nation's money supply growth outpaces economic growth. To combat this, the monetary
authority (in most cases, the central bank) takes the necessary steps to manage the money
supply and credit to keep inflation within permissible limits and keep the economy running
smoothly.

Theoretically, monetarism is a popular theory that explains the relationship between

inflation and the money supply of an economy. For example, following the Spanish conquest
of the Aztec and Inca empires, massive amounts of gold and especially silver flowed into the
Spanish and other European economies. Since the money supply rapidly increased, the value
of money fell, contributing to rapidly rising prices.Inflation is measured in a variety of ways
depending on the types of goods and services. It is the opposite of deflation, which indicates
a general decline in prices when the inflation rate falls below 0%. Keep in mind that deflation
shouldn't be confused with disinflation, which is a related term referring to a slowing down in
the (positive) rate of inflation.

1.2 Causes of Inflation

An increase in the supply of money is the root of inflation, though this can play out
through different mechanisms in the economy. A country's money supply can be increased by
the monetary authorities by:

 Printing and giving away more money to citizens

 Legally devaluing (reducing the value of) the legal tender currency
 Loaning new money into existence as reserve account credits through the banking
system by purchasing government bonds from banks on the secondary market (the most
common method)

In all of these cases, the money ends up losing its purchasing power. The mechanisms
of how this drives inflation can be classified into three types: demand-pull inflation, cost-push
inflation, and built-in inflation.

1.2.1 Demand-Pull Effect

Demand-pull inflation occurs when an increase in the supply of money and credit
stimulates the overall demand for goods and services to increase more rapidly than the
economy's production capacity. This increases demand and leads to price rises. When
people have more money, it leads to positive consumer sentiment. This, in turn, leads to
higher spending, which pulls prices higher. It creates a demand-supply gap with higher
demand and less flexible supply, which results in higher prices.

The opposite will happen when aggregate demand decreases; firms facing lower
demand will either pause hiring or make staff redundant which means that fewer staff are
required. This puts upward pressure on the unemployment rate. More workers searching
for jobs means that firms can offer lower wages, putting downward pressure on
household incomes, consumer spending and the prices of their goods and services. As a
result, inflation will decrease.

1.2.2 Cost-Push Effect

Cost-push inflation is a result of the increase in prices working through the

production process inputs. When additions to the supply of money and credit are
channeled into a commodity or other asset markets, costs for all kinds of intermediate
goods rise. This is especially evident when there's a negative economic shock to the
supply of key commodities. These developments lead to higher costs for the finished
product or service and work their way into rising consumer prices. For instance, when the
money supply is expanded, it creates a speculative boom in oil prices. This means that
the cost of energy can rise and contribute to rising consumer prices, which is reflected in
various measures of inflation.

Cost-push inflation can also arise due to supply disruptions in specific industries –
for example, due to unusual weather or natural disasters. Periodically, there are major
cyclones and floods that damage large volumes of agricultural produce and result in
significant increases in the price of processed food and both takeaway and restaurant
meals, resulting in temporary periods of higher inflation.

1.2.3 Built-in Inflation

Built-in inflation is related to adaptive expectations or the idea that people expect
current inflation rates to continue in the future. As the price of goods and services rises,
people may expect a continuous rise in the future at a similar rate. As such, workers may
demand more costs or wages to maintain their standard of living. Their increased wages
result in a higher cost of goods and services, and this wage-price spiral continues as one
factor induces the other and vice-versa. For example, if firms expect future inflation to be
higher and act on those beliefs, they may raise the prices of their goods and services at
a faster rate. Similarly, if workers expect future inflation to be higher, they may demand
 higher wages to make up for the expected loss of their purchasing power. These
behaviour, sometimes called ‘inflation psychology’, can contribute to a higher rate of
actual inflation so that expectations about inflation become self-fulfilling.
2.0LITERATURE REVIEW

No Quote Author Journal Tittle

.
1
Chen, et al. (2017) developed Bill Y Chen The Productivity,
an economic growth model and Economic
showed that an economy’s Structure and
growth fully and only relies on Middle-income
its changes of the economic Trap--Can China
structure, productivity and Avoid this Trap?
labor participation.

2 Macro Models for

Inflation causes more savings Lance Taylor Developing
and investments (Taylor, Countries
1979).

3
Berk (1999) measures inflation Jan Marc Berk Measuring
expectations and their inflation
influence on inflation, expectations: A
analyzing survey-based survey data
expectations. Berk used what approach. Applied
the authors call a “variation of Economics
the Carlson-Parkin probability
method” since it allows a time-
varying response by not
assuming unbiased survey
expectations, using past and
future price development
information. These results
showed that inflation
expectations were not
stationary and were generally
cointegrated, so both the
expectations and the inflation
rates proved to have a long-run
relation.

4
(Phillips 1958, Phelps 1967), A. W. Phillips The Relation
there is a stable and inverse between
relationship between inflation unemployment
and unemployment. and the rate of
change of money
wages in the
United Kingdom

5
Inflation raises the cost of the Tim Josling Understanding
 production so the prices of international
products; consequently these trade in
products will be less agricultural
competitive in the global products: one
markets (Josling et al. 2010) hundred years of
contributions by
agricultural
economists

6
There are different types of Frederic S. Monetary policy
economic policies but some of Mishkin & Miguel strategies for
them are interdependent. A A. Savastano Latin America
flexible exchange rate system
requires a stable and well
functioning inflation target
(Mishkin and Savastano 2001)

7
Smaghi (2013) stated that Lucrezia Reichlin Who killed the
inflation was not the problem /Richard Baldwin inflation target?”
but its economic growth during In: Is Inflation
a global financial crisis. Targeting Dead?
Central Banking
After the Crisis

8
As Wimer and Jaravel Christopher The Costs of
(2019) ’s study demonstrated Wimer and Xavier being poor:
that the unequal effect of Jaravel. inflation
inflation led many million more inequality leads
people to poverty. to three million
more people in
poverty

9
Inflation is a dangerous Milton Friedman The Optimum
disease that can destroy Quantity of Money
society as Nobel Economics and Other Essays
Laureate Milton Friedman
(1969) repeatedly warned.

10
Inflation influences the N. Georgescu- Structural
economy and its growth Roegen inflation-lock and
implicitly. On the one hand, balanced growth
inflation induces forced
savings (Goergescu-Roegen
1969, ) that will further push
investment so affect the
economy.

11
The basic conclusions are that A. Senhadji Threshold effects
an inflation threshold exists Semlali and in the relationship
 and that this cutting-off rate Mohsin S. Khan between inflation
depends on the specific and growth
economic characteristics
(Khan and Waqas 2020).

12
Abdullah and Kalim (2012) aimed to Muhammad Abdullah Empirical analysis of
determine the main factors influencing and Rukhsana Kalim food price inflation in
food price inflation in Pakistan. Many Pakistan
factors can influence food prices on
both supply and demand side, and
knowing those factors is crucial;
however, more recently inflation
expectations seem to be the variable
in the spotlight.

13
Carvalho and Minella (2012) study the Fabia A. Carvalho A. Survey forecasts in
effects of the inflation targeting Brazil: A prismatic
strategy in Brazil based on survey assessment of
forecasts and inflation expectations. epidemiology,
These surveys are carried out at a performance, and
sectorial level. The origin of determinants. Journal
expectations may be the rational way of International Money
economic agents make decisions and Finance

14
In the study by Wimanda, Turner, and Rizki E. Wimanda Expectations and the
Hall (2011), an important statement is inertia of inflation: The
made to analyze inflation dynamics in case of Indonesia
Indonesia after adopting an inflation
target scheme. In this case, inflation
expectations play an essential role in
controlling the variability of the inflation
rate, allowing it to adjust better to the
previously set target.

15
Ueda (2010) focuses on a Kozo Ueda Determinants of
comparative exercise based on households’ inflation
household inflation expectations, expectations in Japan
identifying that households’ and the United States
expectations change quickly, which
may be explained by their beliefs
about food and energy prices.

16
Dua (2008) affirms that consumers’ Pami Dua Analysis of
expectations influence the demand for consumers’
housing. Specifically, some of the perceptions of buying
determinants of consumer’s perception conditions for houses
of buying houses are housing sector
variables (prices and rates), their
economic condition (income disposal),
and expected economic conditions
(expected rates and changes in
financial status).

17
The article of Armona, Fuster, and Luis Armona, Andreas Home price
Zafar (2019) encompasses the Fuster, Basit Zafar expectations and
formation of home price expectations behaviour: Evidence
and the behavior of families regarding from a randomized
 those expectations; this is measured information
via a survey performed by the experiment
researchers. The expected behavior of
the respondents is based on two
conditions: the expectations are
influenced by their beliefs about future
price changes, and the respondents
are not fully informed about past price
changes.

18
McAdam and Willman (2013) centers Peter McAdam And A. Technology,
its analysis on the understanding of Alpo Willman utilization, and
inflation and its implication as a policy inflation: What drives
setting device. The estimation of the the new Keynesian
curve could be improved, as the Phillips Curve?
authors propose, in correlation with the
economic cycle.

19
Caputo’s (2022) work is centered Rodrigo Caputo Addiction to inflation
around the Chilean context with or to fiscal deficits?
inflation, revolving in four areas: fiscal The Chilean
deficit, monetary expansion, exchange experience of 1970s.
rate policy, and wage rate policy.

20
According to Mensah, Allotey (2019), Lord Mensah, What Debt Threshold
the goal of basic macroeconomics is to Divine Allotey, Hampers Economic
achieve sustainable economic growth Emmanuel Sarpong- Growth in Africa?
by maintaining a low inflation. Kumankoma,
William Coffie
21
According to McConnell, Brue (2022), Stanley Brue and Essentials of
the rise in the overall price level is Campbell Mcconnell Economics
referred to as inflation and in a
situation where inflation is high, the
purchasing power of goods and
services is declining.

22
Baharumshah and Soon (2014) Ahmad Zubaidi Inflation, Inflation
conducted a study in relation to the Baharumshah, and Uncertainty and
Malaysian economy and revealed that Siew-Voon Soon Output Growth
the upward inflation decreased
uncertainty but on the contrary,
economic instability decelerated the
output growth in the economy.

23
In general, inflation was deliberated as Stasys Girdzijauskas New Approach to
a crucial issue in sustainable & Dalia Streimikiene Inflation Phenomena
economic growth, because the latter is to Ensure Sustainable
a key factor in affirmative economic Economic Growth
health as pointed out by Girdzijauskas,
Streimikiene (2022)

24
For analysis in Taiwan and Japan, Lee Chien-Chiang Lee and Inflationary Threshold
and Wong (2005) referred the Swee Yoong Wong Effects in the
regression model to investigate the Relationship between
link between the inflation threshold Financial
and economic growth. Development and
 Economic Growth.

25
Hoang (2020), in the long run, an Ngoc Bui Hoang The Asymmetric
increase in the inflation rate has a Effect of Inflation on
greater impact than a decrease and Economic Growth in
severe inflation will inflict damage on Vietnam
economic activity.

26
Faria and Carneiro (2001) a confirmed Joao Ricardo Faria & Does High Inflation
that inflation does not affect the real Francisco Galrao Affect Growth in the
output in the long run and it does have Carneiro Long and Short Run?
a negative impact on real output in the
short run.

27
Akinsola and Odhiamb (2017) Akinsola, Foluso A.; Inflation and
indicates that inflation affects Odhiambo, Nicholas Economic Growth
economic growth over time due to M
changes in the charasteristics of
developed and developing countries.

28
Khan (2021) stated that apart from Najib Khan Does Inflation
inflation, many factors affect economic Targeting Really
growth, such as the monetary policy Promote Economic
as a key economic factor and Growth?
unemployment rate.

29
Armantier, Kosar (2021) during this Olivier Armantier How Economic Crises
pandemic, consumer expectations and & Gizem Kosar Affect Inflation Beliefs:
inflation uncertainty increased. The Evidence from the
rise in inflation uncertainty has been Covid-19 Pandemic.
attributed to the high rate of
precautionary savings.

3.0 OPINION BASED ON THE TOPIC (The Inflation: What are the pros and
cons of inflation on the economy)

The primary impact of inflation is decreasing purchasing power. Although the

denomination of currency doesn't change, the impact of inflation is that the same amount of
currency can buy less across inflationary periods. Though individuals may receive the cost of
living adjustments to wages they take home, they more commonly see repercussions in the
groceries they buy, the rent they pay, and transactions they incur. As a result of higher
inflation, the Federal Reserve often enacts monetary policy leading to higher federal funds
rates. Higher federal funds rates have a domino effect to many other forms of lending and
cause the cost of debt to be higher. Higher federal funds rates often, and credit card rates.

Because of higher debt rates, a downstream effect of higher inflation is a slower

economy. During inflationary periods, prices are higher, and it is more expensive to incur
debt. For these two reasons, companies often sell fewer products and the economy slows.
This may lead to diminished corporate profits, layoffs, and pressures on households. The end
result of this cycle of events is a potential recession. The Federal Reserve tries to balance
stemming inflation and maintaining acceptable levels of unemployment. However, each of the
two items often moves in opposite directions. Their policies often increase one and decrease
the other. Though there are no guarantees on the downstream effects of monetary policy, the
Federal Reserve often risks causing a recession when combating inflation.

When the economy is not running at capacity, meaning there is unused labor or
resources, inflation theoretically helps increase production. More dollars translates to more
spending, which equates to more aggregated demand. More demand, in turn, triggers more
production to meet that demand. British economist John Maynard Keynes believed that some
inflation was necessary to prevent the Paradox of Thrift. This paradox states that if consumer
prices are allowed to fall consistently because the country is becoming too productive,
consumers learn to hold off their purchases to wait for a better deal. The net effect of this
paradox is to reduce aggregate demand, leading to less production, layoffs, and a faltering
economy. Economists once believed an inverse relationship existed between inflation and
unemployment, and that rising unemployment could be fought with increased inflation. This
relationship was defined in the famous Phillips curve. The Phillips curve was somewhat
discredited in the 1970s when the U.S. experienced stagflation.

Inflation makes it easier on debtors, who repay their loans with money that is less
valuable than the money they borrowed. This encourages borrowing and lending, which again
increases spending on all levels. For example, if a debtor has $10,000 of debt during an
inflationary period, that debt has less worth as time progresses. From a purchasing power
standpoint, it's more advantageous to slowly pay off this debt during highly inflationary
periods due to the debt's diminishing value. More specifically, homeowners that have agreed
to long-term, fixed mortgages may benefit from inflation. Higher rates often push prospective
buyers out of the market, so those who are in greater financial positions may benefit from the
diminished housing market. Because of the slowing economy and risk of recession,
individuals that have tenure at their job or are in more secure positions often benefit. People
in positions of less demand or start-up departments/companies are more at-risk of corporate
budget cuts. When inflation is higher, the purchasing power of one country's currency often
weakens against other international currencies. This often causes downward pressure that
strengthens the value of international currencies in relation to the inflationary currency. Those
owning foreign currency that take advantage of favorable exchange rates may benefit from
inflation of another country.

Deflation (a fall in prices – negative inflation) is very harmful. When prices are falling,
people are reluctant to spend money because they feel that goods will be cheaper in the
future; therefore they keep delaying purchases. Also, deflation increases the real value of
debt and reduces the disposable income of individuals who are struggling to pay off their
debt. When people take on a debt like a mortgage, they generally expect an inflation rate of
2% to help erode the value of debt over time. If this inflation rate of 2% fails to materialize,
their debt burden will be greater than expected. Periods of deflation caused serious problems
for the UK in 1920s, Japan in 1990s and 2000s and Eurozone in 2010s. Moderate inflation
enables adjustment of wages. It is argued a moderate rate of inflation makes it easier to
adjust relative wages. For example, it may be difficult to cut nominal wages (workers resent
and resist a nominal wage cut). But, if average wages are rising due to moderate inflation, it is
easier to increase the wages of productive workers; unproductive workers can have their
wages frozen – which is effectively a real wage cut. If we had zero inflation, we could end up
with more real wage unemployment, with firms unable to cut wages to attract workers. When
the cost of goods goes up, consumers need to have more money to purchase them. When
this happens they tend to push their employers for higher wages. In order to remain
competitive, employers have to continually offer higher wages. This has an added benefit for
businesses as well; they have a built-in incentive to only hire productive workers since they’re
paying a higher wage. This allows businesses to trim those who are under performing and
replace them with better employees. For the average worker, jobs pay more and are more
plentiful.

Inflation enables adjustment of relative prices. Similar to the last point, moderate
inflation makes it easier to adjust relative prices. Businesses are able to price their products
more effectively when demand is higher. Better sales mean better and more plentiful jobs for
consumers. This becomes a positive cycle which means that you tend to get a better deal for
products you want. This is particularly important for a single currency like the Eurozone.
Southern European countries like Italy, Spain and Greece became uncompetitive, leading to
large current account deficit. Because Spain and Greece cannot devalue in the Single
Currency, they have to cut relative prices to regain competitiveness. With very low inflation in
Europe, this means they have to cut prices and cut wages which cause lower growth (due to
the effects of deflation). If the Eurozone had moderate inflation, it would be easier for
southern Europe to adjust and regain competitive without resorting to deflation. Inflation can
boost growth. At times of very low inflation, the economy may be stuck in a recession.
Arguably targeting a higher rate of inflation can enable a boost in economic growth. This view
is controversial. Not all economists would support targeting a higher inflation rate. However,
some would target higher inflation, if the economy was stuck in a prolonged recession. See:
Optimal inflation rate. For example, the Eurozone has had a very low inflation rate in 2013-14,
and this has corresponded to very weak economic growth and very high unemployment. If the
ECB had been willing to target higher inflation, then we could have seen a rise in Eurozone
GDP.

The Phillips Curve suggests there is a trade-off between inflation and unemployment. Higher
inflation leads to lower unemployment (at least in the short-term) there is a debate about how
meaningful this trade off is.

Inflation is better than deflation. The only thing worse than inflation, joke economists, is
deflation. A fall in prices can cause an increase in the real debt burden and discourage
spending and investment. Deflation was a factor in the Great Depression of the 1930s.
Perhaps the most powerful argument in favour of inflation is that the alternative is disastrous.
Deflation occurs when the value of a currency falls. The price of products follows suit because
consumers won’t be able to purchase at higher prices. This can continue until it is no longer
profitable to actually create products. In addition, when consumers see prices headed down,
they are less likely to purchase or invest, hoping for cheaper prices down the road. Deflation
was a major factor during the Great Depression in the 1920s and 30s.

It’s not all good news. There are some cons to inflation that can affect your bottom line.
These mostly apply to higher than normal inflation because a moderate amount is nearly
always a positive. Inflation is usually considered to be a problem when the inflation rate rises
above 2%. The higher the inflation, the more serious the problem is. In extreme
circumstances, hyperinflation can wipe away people’s savings and cause great instability, e.g.
Germany 1920s, Hungary 1940s, Zimbabwe 2000s. However, in a modern economy, this kind
of hyperinflation is rare. Usually, inflation is accompanied with higher interest rates, so savers
do not see their savings wiped away. However, inflation can still cause problems.

Inflationary growth tends to be unsustainable leading to a damaging period of boom and

bust economic cycles. For example, the UK saw high inflation in the late 1980s, but this
economic boom was unsustainable, and when the government tried to reduce inflation, it led
to the recession of 1990-92.Higher inflation, while it may create a booming market for a
moment, is not necessarily sustainable. This is because it leads to unpredictable boom and
bust cycles. The economy will be chugging along great for a bit, but then prices or wages will
hit a wall and things will become unaffordable quickly.
 Inflation tends to discourage investment and long-term economic growth. This is because
of the uncertainty and confusion that is more likely to occur during periods of high inflation.
Low inflation is said to encourage greater stability and encourage firms to take risks and
invest.High inflation is unpredictable, which leads to less investment. Because prices and
values are rising so quickly, investors tend to think that they won’t be that way forever and
choose instead to hold onto cash in a savings account or keep it in safer investments. This
also reduces investment in machinery and other things that are used to create products.

Inflation can make an economy uncompetitive. If inflation is high, that means the cost of
products tends to be higher. This can make a country very uncompetitive with others around
the world. Products may sell around the world for X, but due to inflation, a country can only
sell that product for X*2. For example, a relatively higher rate of inflation in Italy can make
Italian exports uncompetitive, leading to lower AD, a current account deficit and lower
economic growth. This is particularly important for countries in the Euro-zone because they
can’t devalue to restore competitiveness.

Reduce the value of savings. Inflation leads to a fall in the value of money. This makes
savers worse off – if inflation is higher than interest rates. High inflation can lead to a
redistribution of income in society. Often it is pensioners who lose out most from inflation. This
is particularly a problem if inflation is high and interest rates low. Fall in real wages. In some
circumstances, high inflation can lead to a fall in real wages. If inflation is higher than nominal
wages, then real incomes fall. This was a problem in the great recession of 2008-16, with
prices rising faster than incomes.
 Graph showing high inflation during a period of low growth caused a fall in real wages 2008-2014 in UK

Inflation (CPI) above wage growth 2008-14, caused a decline in living standards – especially
for workers in low-wage, zero-hour contract jobs.

There are many costs associated with inflation; the volatility and uncertainty can lead to
lower levels of investment and lower economic growth. For individuals, inflation can lead to a
fall in the value of their savings and redistribute income in society from savers to lenders and
those with assets. At extreme levels, inflation can destabilization society and destroy
confidence in the economic system. The theory states that economic growth causes inflation
and lead to more jobs and less unemployment. Similarly, low unemployment rate induces
high wage so inflation. Thus, inflation and unemployment move in opposite directions.
Although there have been many empirical approvals of this theory, the occurrence of
stagflation in the 1970s, in which both inflation and unemployment were high, questions its
validity. Also, during 1990s, the US experienced the low inflation, low interest rate and low
unemployment rate.

The graft is the US inflation rates and unemployment rates from January 1948 to April
2022. These two variables are not closely correlated. Its correlation coefficient is 0.0708,
which is statistically insignificant. Nonetheless, in the past two years, the world has observed
the Phillips curve again. In the US, its inflation has been very high while the unemployment
rate has been extremely low. The correlation coefficient of inflation rates and unemployment
rates from 2021 to April 2022 is -0.9254 and it is significant statistically
 Inflation will lead to a higher interest rate since the central bank has the mandatory
responsibility to control inflation and its primary tool is to raise the rate. So interest rates tend
to move in the same direction as inflation but with lags. In the U.S, the Federal Reserve
targets an average annual inflation rate of 2% since 2012. On the other hand, the central
bank will do the opposite, lower interest rates to stimulate the economy, when inflation is
falling and economic growth is slowing. Figure 4 shows the relationship between the inflation
(CPI) and one-year T-bill rates (1990-2022). The trends of two curves have been generally
consistent. The correlation coefficient between these two variables is 0.3964 and that is
statistically significant. This relationship shows that the Federal Reserve in the US has been
successful normally in managing and controlling the inflation. However, when the inflation is
extremely high, such as about 19% in early 1980s, it will be very difficult to cool it down
quickly even if the interest rate is raised to the enormously high level like 10%.

Trade is crucial to an economy’s development. The world’s trade has been significantly
increased since 1990s although in some years there were decreases during the economic
recessions/crises such as in 2009 and 2020. The world’s highest ratio of the trade to GDP
was 60.78% in 2008 but in 2009, it dropped to only 52.32%, according to the World Trade
Organization (WTO). In most western countries, its trade to GDP ratio has been about 30%;
in China it was over 60% in 2007 and now is about 35% (Chen et al. 2015, 2019). Trade
promotes the economic development and also has been an important indicator of the global
economy. During the COVID-19, the international trade has been more resilient to the
economic downturn, compared that during the 2008-2009 economic crisis. Inflation impacts
economic growth so affects international trade. When the global economy’s growth is slower,
the demand for products and services will be lower, and then global imports will be
decreased. Also, inflation raises the cost of the production so the prices of products;
consequently these products will be less competitive in the global markets. As a result, high
inflation leads to lower global export. Moreover, trade, in return, impacts inflation. Studies
have indicated that inflation in opening economies has been increasingly determined abroad
although wage and core inflation are still mainly domestic processes. In other words, the CPI
inflation in the US is import-generated, except rising of wage and core consumption products’
prices (Forbes 2019).
 Rate Inflation may impact a currency’s exchange rate. In a fixed change rate regime,
inflation raises the cost of products and services; as a result, without the adjustment of the
exchange rate, its products and services will be less competitive so less attractive and that
will lead to the reduction of the exports. At the same time, assuming the other factors are not
changed, imported products and services will be more competitive and relatively cheaper
since the prices of the foreign-made products are not changed but domestic ones are more
expensive. Consequently the balance of trade and balance of payments of the country will be
worsen. This will force the country to adjust its exchange rate policy and depreciate its
currency value; otherwise its international currency reserves will be continuously decreased.
In a flexible exchange rate regime, inflation will push its currency to be depreciated in order to
keep its competitiveness of the products and services in the world; otherwise the export firms
will lose profits. Generally, inflation inclines to diminish a currency because inflation can be
equated with a money's purchasing power reduction. Therefore, high inflation economies tend
to experience weaken currencies relative to other currencies

. Effects of Inflation on Individuals Inflation impacts individuals unequally. First, low

income and fixed income people suffer most. Sharp price increases in food, energy and other
necessities hurt all consumers but lower-income households dedicate a higher percentage of
their income on necessities so they are harmed most by high inflation. Jaravel (2021) found
that annual inflation for retail products was 0.661 percentage points higher for the bottom
income quintile relative to the top quintile and applying Feenstra (1994)’s method to the
expanding product variety, based on the Consumer Expenditure Survey (CES), this inflation
inequality rises to 0.8846 percentage points a year. Inflation also widens wealth gaps among
different groups. The outcome is that rich people become richer and poor individuals are
poorer. Wimer and Jaravel (2019) estimated that the inflation inequality led 3.2 million more
people in poverty in the US from 2004 to 2018 and that real income for the bottom 20%
household essentially reduced by nearly 7% since 2004, instead of a decline of about 1%
using official CPI. These results imply that inflation inequality considerably heightens both the
rate of poverty and real income inequality.

Inflation enriches wealthy people because they had businesses and other investments
which benefit from inflation. For example, they own more real assets like properties that will
be increasingly appreciated with inflation. The U.S. Bureau of Labor Statistics (BLS) data
showed that the house prices are 850.54% higher in 2022 compared with 1967. From 1967 to
2022, US housing had an average rate pf return of 4.18% per year, compared to the overall
inflation rate of 3.98% during this same period. In other words, housing costing $100,000 in
the year 1967 would cost $950,536.40 in 2022 for an equivalent purchase. The correlation
coefficient between quarterly house price index and CPI from January 1975 to March 2022 in
the US is 0. 2273 that is significant. Therefore, inflation generally raises the house prices
significantly.

Moreover, high inflation and especially extremely excessive inflation often causes
serious social problems, high crimes and instability of society. Consequently, all citizens
suffer but poor and low income people are hurt most since they are living and working usually
in the less safe districts. Figure 7 is the US inflation and crime rates from 1960 to 2019.
Generally, inflation and crimes rates were moved consistently. The correlation coefficient
between the inflation and the overall crime rates of the burglary and thefts is 0.3691, which is
significant statistically.
4.0 CONCLUSION

Generally, Inflation is caused by the fall in aggregate supply to equal the increase in
aggregate demand. It can be controlled by increasing the supplies of goods and services and
reducing money incomes in order to control aggregate demand. High inflation may cause
negative impact to a particular country. A moderate amount of inflation is a good thing for the
economy. With a moderate amount of inflation, wages tend to increase, and although product
prices increase as well, the two move in tandem allowing consumers to continue purchasing.
Moderate inflation also allows for stable and appropriate wage increases, meaning that
consumers have more money to invest and spend. High inflation is bad for you because it can
lead to an unsustainable and wild economic environment where the cost of products outpaces
your paycheck. Low inflation means an economy is stagnating and paychecks may fall,
making it harder for you to spend. As with all things, moderation is key.

The practice of inflation targeting over the past 25 years has fundamentally changed the
character of target inflation measures. Unlike in the early years of inflation targeting, before
credibility had been established, long-term inflation expectations are firmly anchored at target,
moving little in response to inflation surprises. Variability of the domestic component of
inflation has declined substantially, and much of the variation in CPI inflation is now caused
by imported shocks, such as commodity price and exchange rate changes. Stabilization of the
domestic component of inflation has weakened the relationship between inflation and
domestic economic conditions – the Phillips curve has become flatter. These changes in the
inflation process have resulted in a breakdown in the correspondence between output and
inflation stabilization. Changes in CPI inflation are now more likely to reflect idiosyncratic
shocks than signal deviations in output from potential. Some critics argue that this calls for
inflation-targeting frameworks to be fundamentally re engineered, placing more weight on
output than inflation stabilization. It is argued by some that weighting output more heavily in
central banks' objective function would avoid the stability of inflation blinding central banks to
spare capacity, and reduce the likelihood of inappropriate monetary policy tightening in
response to imported price shocks.

In addition, it seems that the peak of rising overall prices is already over or to be over
soon in most economies although that will not go down quickly. More importantly, the US and
many other countries have learned from past experiences on how to control soaring inflation
using all types of tools, including monetary and fiscal policies and even administrative or
executive powers. Financial systems and financial resources are also stronger now than
before. The paper concludes that there may be a minor economic recession if the current high
inflation lasts extensively but the US and world can avoid an economic crisis if take strong
and effective actions to control and reduce the present high inflation. More importantly, it is
essential that the world learns and knows how to prevent and avoid the next high inflation
cycle. Inflation cannot be avoided but high inflation, especially extremely high inflation can be
prevented. Particularly, the world should aim at reforming the existing economic and financial
systems to be more inclusive and sustainable, solving the rising income and wealth inequality
problem and better developing and using the new technologies that can benefit all more
equally, improve environment, further enhance efficiency and continuously raise the
productivity.

In a macroeconomic sense, the expectations over inflation proved to be one of the most
influential variables in the economic spectrum. In recent years, the importance of the
expectations in the macroeconomic study field gained importance as they are significant
within the dynamics of the economy, according to the econometric models shown. Even
though expectations became a crucial element in the policy making of the countries, this is an
element that indicates the population’s perception of the work of the central banks that helps
keep the economy stable. For many, inflation is scary and detrimental. For others, inflation is
a necessary part of growing the economy. An important consideration of inflation is the
government's response which often raises interest rates, slows the economy, and increases
the risk of inflation. During inflationary periods, some parties benefit while others face greater
risks.
5.0 REFERENCES

1. Josling, Tim, et al. (2010), “Understanding international trade in agricultural products:

one hundred years of contributions by agricultural economists;” American Journal of
Agricultural Economics, April, 92(2), pp. 424-446.

2. Mishkin, Frederic S. and Miguel A. Savastano (2001), “Monetary policy strategies for
Latin America,” Journal of Development Economics, 66(2): pp. 415-444.

3. Chen, Yueyun(Bill), et al (2017), “The Productivity, economic structure and middle-

income trap—can China avoid this trap?” Journal of Applied Business and Economics,
19(11), pp. 78-103.
4. Taylor, Lance (1979), Macro Models for Developing Countries. New York: McGraw-Hill.

5. Phillips, A. W. (1958), “The Relation between unemployment and the rate of change of
money wages in the United Kingdom,1861–1957,” Economica, 25 (100);pp. 283–99.

6. Smaghi, Lorenzo Bini (2013), “Who killed the inflation target?” In: Is Inflation Targeting
Dead? Central Banking After the Crisis, edited by Lucrezia Reichlin and Richard Baldwin,
Centre for Economic Policy Research, pp. 31-36.

7. Wimer, C, Collyer S, and Jaravel X. (2019), “The Costs of being poor: inflation inequality
leads to three million more people in poverty;” Policy Brief, Cent. Poverty Soc. Policy,
Columbia Univ., New York.

8. Friedman, Milton (1969), The Optimum Quantity of Money and Other Essays
(Chicago:Aldine)

9. Goergescu-Roegen, Nicholas (1969), "Structural inflation-lock and balanced growth;"

Economies et Societe's 4,March, pp. 557-605

10. Khan, M.S. and Senhadji A.S. (2001), “Threshold effects in the relationship between
inflation and growth;” IMF Staff papers, 48(1), pp. 1–21.

11. BERK, J. M. Measuring inflation expectations: A survey data approach. Applied

Economics, v. 31, n. 11, p. 1467-1480, 19991 DOI :
https://doi.org/10.1080/000368499323337

12. ABDULLAH, M.; KALIM, R. Empirical analysis of food price inflation in Pakistan. World
Applied Sciences Journal, v. 16, n.7, p.933-939, 2012. Available at: Available at:
http://escholar.umt.edu.pk:8080/jspui/bitstream/123456789/492/3/Full%20View.pdf
Accessed on: 20 Mar. 2021.

13. CARVALHO, F. A.; MINELLA, A. Survey forecasts in Brazil: A prismatic assessment of

epidemiology, performance, and determinants. Journal of International Money and
Finance, v. 31, n. 6, p. 1371-1391, 2012. DOI:
https://doi.org/10.1016/j.jimonfin.2012.02.006

14. WIMANDA, R. E.; TURNER, P. M.; HALL, M. J. Expectations and the inertia of inflation:
The case of Indonesia. Journal of Policy Modeling, v. 33, n. 3, p. 426-438, 2011. DOI:
https://doi.org/10.1016/j.jpolmod.2010.08.009

15. UEDA, K. Determinants of households’ inflation expectations in Japan and the United
States. Journal of the Japanese and International Economies, v. 24, n. 4, p. 503-518,
2010. DOI: https://doi.org/10.1016/j.jjie.2010.06.002
16. ARMONA, L.; FUSTER, A.; ZAFAR, B. Home price expectations and behaviour:
Evidence from a randomized information experiment. Review of Economic Studies, v. 86,
n. 4, p. 1-40, 2019. DOI: https://doi.org/10.1093/restud/rdy038

17. DUA, P. Analysis of consumers’ perceptions of buying conditions for houses. The
Journal of Real Estate Finance and Economics, v. 37, n. 4, p. 335-350, 2008. DOI:
https://doi.org/10.1007/s11146-007-9084-0

18. MCADAM, P.; WILLMAN, A. Technology, utilization, and inflation: What drives the new
Keynesian Phillips Curve? Journal of Money, Credit and Banking , v. 45, n. 8, p. 1548-
1579, 2013. Available at: Available at: https://www.jstor.org/stable/42920085 Accessed
on: 5 May 2021.

19. CAPUTO, R. Addiction to inflation or to fiscal deficits? The Chilean experience of 1970s.
International Journal of Financial Economics, v. 27, n. 1, p. 99-110, 2022. DOI:
https://doi.org/10.1002/ijfe.2140

20. Mensah L, Allotey D, Sarpong-Kumankoma E, Coffie W. What Debt Threshold Hampers

Economic Growth in Africa? International Journal of Development Issues.
2019;19(1):25–42. doi: 10.1108/ijdi-03-2019-0056

21. McConnell CR, Brue SL, Flynn SM. Essentials of Economics. Eighteenth Edition ed:
Douglas Reiner; 2012.

22. Baharumshah AZ, Soon SV. Inflation, Inflation Uncertainty and Output Growth: What
does the Data Say for Malaysia? Journal of Economic Studies. 2014;41(3):370–86.

23. Girdzijauskas S, Streimikiene D, Griesiene I, Mikalauskiene A, Kyriakopoulos GL. New

Approach to Inflation Phenomena to Ensure Sustainable Economic
Growth. Sustainability. 2022;14(1):518–39.

24. Lee CC, Wong SY. Inflationary Threshold Effects in the Relationship between Financial
Development and Economic Growth: Eviednce from Taiwan and Japan. Journal of
Economic Development. 2005;30(1):49–69.

25. Hoang BN. The Asymmetric Effect of Inflation on Economic Growth in Vietnam: Evidence
by Nonlinear ARDL Approach. The Journal of Asian Finance, Economics and Business.
2020;7(2):143–9. doi: 10.13106/jafeb.2020.vol7.no2.143

26. Faria JR, Carneiro FG. Does High Inflation Affect Growth in the Long and Short Run?
Journal of Applied Economics. 2001;4(1):89–105. doi:
10.1080/15140326.2001.12040559

27. Akinsola FA, Odhiamb NM. Inflation and Economic Growth: A Review of The
International Literature. Comparative Economic Research. 2017;20(3):41–56. doi:
10.1515/cer-2017-0019

28. Khan N. Does Inflation Targeting Really Promote Economic Growth? Review of Political
Economy. 2021;6(1):1–21. doi: 10.1080/09538259.2021.1902165

29. Armantier O, Kosar G, Pomerantz R, Skandalis D, Smith K, Topa G, et al. How

Economic Crises Affect Inflation Beliefs: Evidence from the Covid-19 Pandemic. Journal
of Economic Behavior & Organization. 2021;189(1):443–69. doi:
10.1016/j.jebo.2021.04.036