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1 1 (September 26, 2016)

handle is hein.crs/goveari0001 and id is 1 raw text is: I nfr in th Us. E c e 1914 Introduction to U.S. Economy: Inflation September 26, 2016 What is Inflation? Inflation is defined as a general increase in the price of goods and services across the economy; in other words, a general decrease in the value of money. Conversely, deflation is a general decrease in the price of goods and services across the economy, or a general increase in the value of money. As inflation occurs, individuals can purchase fewer goods and services with the same amount of money. For this reason, an individual would need about $287 in 2015 to purchase the same amount of goods and services as $100 could have purchased in 1980. Measures of inflation are used to adjust money figures to keep purchasing power constant over time, allowing for more accurate comparisons across disparate time periods. Monetary figures adjusted for inflation are referred to as real, and non-inflation adjusted figures are referred to as nominal. Causes of Inflation Inflation is largely the result of two different phenomena, which are often referred to as demand-pull and cost-push inflation. Demand-pull inflation occurs when demand for goods and services within the economy exceeds the economy's capacity to produce goods and services. As demand exceeds supply within the economy, too much money chasing too few goods, there is upward pressure placed on prices resulting in rising inflation. Cost-push inflation occurs when the price of input goods and services increases. The classic example of cost-push inflation is the result of an oil shock, which sharply decreases the supply of oil and other petroleum products. The decrease in oil supplies increases the price of oil and petroleum products. Petroleum products are an input good for a significant portion of goods and services across the economy, and as the price of this important input good increases so does the price of the final goods and services resulting in inflation. Cost-push inflation only results in a temporary increase in inflation, unless accommodated by monetary policy. In addition, changes in inflation expectations can also cause changes in actual inflation. Individuals form expectations around the future rate of inflation and incorporate those expectations, when setting prices at the firm level or when bargaining for wages as a worker. For example, if a worker expects the inflation rate to increase over the next year, he or she may demand higher nominal wages to offset a decrease in real wages. Wages are a significant production cost for many products, and the overall price of goods and services will rise to reflect the increase in the cost of labor. An increase in inflation expectations will cause actual inflation to increase, and vice versa, all else equal. Inflation's Impact on the Economy Inflation tends to interfere with pricing mechanisms in the economy, resulting in individuals and businesses making less than optimal spending, saving, and investment decisions. Additionally, in the presence of inflation, economic actors often engage in actions to protect themselves from the negative impacts of inflation, diverting resources from other more productive activities. Ultimately, these inefficient decisions reduce incomes, economic growth, and living standards. For this reason, it is generally accepted that inflation should be kept low to minimize these distortions in the economy. Some would argue that an inflation rate of zero is optimal; however, a target of zero inflation makes a period of accidental deflation more likely, and deflation is thought to be even more costly than inflation. In an effort to balance these two risks, policy makers, including the Federal Reserve, often target a positive, but low, inflation rate, generally around 2%, which reduces inefficiencies within the economy while protecting against deflation. Figure I Annual Inflation Rate 1960-20 16 o6 10 Source: Bureau of Economic Analysis. Note: 12-month percentage change as measured by Personal Consumption Expenditures Index. The F ederal Reserve and Inflation The Federal Reserve has been charged with promoting stable prices by statute since the late 1970s, largely as a result of the volatile and exceptionally high inflation experienced during the 1970s, as shown in Figure 1. Beginning in 2012, the Federal Reserve began explicitly targeting a long-run inflation rate of 2%. The Federal Reserve generally uses its ability to impact short-term interest rates to combat demand-pull and cost-push inflation, in an effort to decrease the volatility of inflation and keep inflation close to its target rate. https://crsreports.con gress.gov

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