Is Inflation Negligible?
If the CPI increases to 5%, should the government be concerned?
Since the government gave the MPC a target for the CPI of 2 percent +/-1, it considers inflation beyond 3 percent to be potentially harmful to the economy.
It is based on inflation rates in other nations. The demand for UK exports will decline if inflation in the UK is higher than it is elsewhere, making UK goods less competitive.
A deficit on the current account Balance of Payments may result from a decline in export demand. However, a devaluation that is likely to happen could cancel this out.
The government wants to avoid this since high inflation will result in a devaluation of the currency.
Increased menu expenses may result from higher rates of inflation, which forces businesses to frequently alter their price lists. When inflation is barely 5%, though, this is not especially relevant.
A recession could follow the boom if inflation is brought on by rapid economic growth. The Bank of England will need to raise interest rates in order to keep inflation under target, but doing so will have negative effects on growth because AD will decline.
Businesses detest higher inflation rates because because make it more challenging to forecast future costs. Investment will be reduced as a result, and economies in countries with lower inflation rates tend to grow more slowly.
Because it would violate the Maastricht criteria, a high inflation rate would make joining the EURO more challenging. A single monetary policy would be ineffectual for the UK if UK inflation was higher than that of Europe.
The inflation target of 2.5 percent may need to be adjusted if an increase in oil prices led to inflation on a global scale. Because inflation would be higher in every nation, the UK wouldn't lose its competitive advantage. Stagflation would result from reducing inflation (lower growth and lower prices)
Although it will depend on the interest rate, inflation may result in a shift of income from savers to borrowers. For illustrate, however if interest rates are increased as 8%, savers would still pay a real return rate of 3%.
Whether wages are keeping pace with inflation will determine this. Real wages would be declining if wages were only rising by 4%.
Should the government be concerned if inflation drops below 2%?
The economy will benefit if prices decline as a result of AS shifting to the right due to new technology since growth will increase and more employment will be generated.
If dropping AD results in deflation, this is a major economic issue since that portends a recession with issues such high unemployment, lowered output, and a negative multiplier effect.
The economy may experience difficulty due to deflation. It indicates that individuals who are in debt might experience an increase in the real worth of their debts, which will reduce consumer confidence and possibly reduce AD and economic growth.
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