VI. Writing

Write an essay on the following topic.

Write a letter to the editor of a local newspaper opposing the plan of some chief executives of the local administration that your region should issue its own money. Give valid reasons supporting your point of view.

Unit 10 Inflation

I. Anticipating the Issue

Discuss your answers to the following questions.

1. What is inflation? How does inflation affect people’s income and wealth?

2. Why should inflation cause concern of the government?

II. Background Reading

Read the following text. Focus on the meaning of the boldfaced words. Determine whether what you anticipated coincides with the information of the text.

Inflation

1. Economists measure inflation through a price index, which measures changes in the price level over time. Inflation occurs when the general level of prices of goods and services increases, while deflation occurs when the price level decreases. The most popular measure is the consumer price index (CPI). In order to compile a CPI, first select a market basket that represents commonly purchased goods and services. Then, find the average price of each item and select a base year from which to compare all other years. Finally, convert the currency cost of the market basket into an index value by dividing the cost of every market basket by the base-year market basket cost.

2. To measure inflation, divide the change in the CPI by the beginning value of the CPI. Today many developed countries have creeping inflation —low inflation in the range of 1 to 3 percent. Sometimes inflation can soar, causing hyperinflation in the range of 500 percent or more a year. A period of slow economic growth and inflation is called stagflation.

3. Economists also use the producer price index (PPI) – to measure prices domestic producers receive – and the implicit GDP price deflator –to measure price changes in the GDP.

4. Almost every period of inflation is caused by either one or a combination of the following: a demand-pull inflation, cost-push inflation, wage-price spiral, and/or excessive money growth. According to the demand-pull inflation theory, prices rise because all sectors of the economy try to buy more goods and services than the economy can produce. Excessive demand creates shortages that pull up prices. The cost-push inflation theory claims that rising input costs, especially energy and organised labour, drive up the prices of products. This leads manufacturers to recover increased costs by raising prices. The wage-price spiral, on the other hand, explains that rising prices do not result from a particular group or event but is instead a self-maintaining spiral of wages and prices that is difficult to stop. The spiral may begin when higher prices make workers demand higher wages, which leads to producers trying to recover that cost with higher prices. Excessive monetary growth—when the money supply grows faster than real GDP – is the most popular explanation for inflation. A demand-pull effect that drives up prices occurs when people spend the additional money created by the Federal Reserve System. Advocates of this explanation believe that a growing money supply maintains inflation.

5. High inflation can reduce purchasing power, distort spending, encourage speculation, and affect the distribution of income. Inflation reduces consumers’ purchasing power because the currency buys less as prices rise. In this way, the dollar loses value over time. The reduced purchasing power of the dollar is especially hard for people with fixed incomes, such as retirees.

6. When prices rise, distorted spending patterns emerge because people use their money differently. For example, when there has been a rise in interest rates in the past, spending on durable goods has fallen dramatically. Inflation also encourages speculation. People may try to take advantage of rising prices by investing in ventures with higher risks. However, such investments can lose money, and the average consumer usually can’t absorb heavy losses. Finally, inflation can distort the distribution of income. During periods of long inflation, a creditor, a person or institution who lends money, is generally hurt more, because the debtor, a person who borrows and therefore owes money, pays the earlier loan back with currencies that buy less.