Inflation is predicted to increase in the global economy in 2017 which is a welcoming thought when you consider the threat of deflation. The Economist identified 3 areas that are behind the increase.
1. Imported inflation – producer prices in China are increasing as prices at the factory gate rose by 5.5% and the spare capacity in the economy is getting smaller. Furthermore there has been an improvement in demand especially in Asia. Additionally oil prices have increased to over $50 per barrel up from $30. Therefore a lot the above imports have become more expensive which could lead to higher prices. However a lot will depend on the exchange rate – lower value exchange rate means that imports will be more expensive
2. Capacity pressures – with a reduction in spare capacity goods become more scarce so the price of them should increase. The USA economy is close to full capacity with 4.7% unemployment and US Fed chairman Janet Yellen recently indicated that a further increase in interest rates might be necessary to cool increasing pressure on inflation. In the Euro area there is more spare capacity with the unemployment rate of 9.8% – this is especially prevalent in Italy and Spain. Therefore if the inflation rate is to increase in the Euro area it will need countries like Germany, with a 4.1% unemployment rate, to generate it.
3. Inflationary expectations – expectations of further inflation in the future can lead workers to demand higher wages in anticipation of price increases or lead producers to set higher prices in anticipation of increased costs of production. Inflationary expectations have reached their highest level in 12 years according to a survey of fund managers. But it has also raised fears the world is heading for a period of low growth, higher unemployment and accompanied by high inflation leads to stagflation.
Sources: The Economist, FT
With the Cambridge AS resit exam approaching here are some revision notes on inflation and a diagram that I have found useful. As well as cost-push and demand-pull inflation remember:
In recent years more attention has been paid to the psychological effects which rising prices have on people’s behaviour. The various groups which make up the economy, acting in their own self-interest, will actually cause inflation to rise faster than otherwise would be the case if they believe rising prices are set to continue.
Workers, who have tended to get wage rises to ‘catch up’ with previous price increases, will attempt to gain a little extra compensate them for the expected further inflation, especially if they cannot negotiate wage increases for another year. Consumers, in belief that prices will keep rising, buy now to beat the price rises, but this extra buying adds to demand pressures on prices. In a country such as New Zealand’s before the 1990’s, with the absence of competition in many sectors of the economy, this behaviour reinforces inflationary pressures. ‘Breaking the inflationary cycle’ is an important part of permanently reducing inflation. If people believe prices will remain stable, they won’t, for example, buy land and property as a speculation to protect themselves.