Inflation in the UK EconomyBefore we begin to explain inflation we must first define it. Inflation can be described as a positive growth rate in the general price level of goods and services. It is measured as a percentage increase over time in a price index such as the GDP deflator or retail price index. The RPI is a basket of over six hundred different goods and services, weighted by the percentage of household income they absorb. There are two measurements of this: the prime rate (includes all items in the basket) and the underlying rate (RPIX) which excludes mortgage interest payments. It is the RPIX that is used most often in this country, as a characteristic of the UK compared to the rest of Europe is a very high proportion of home owners/occupiers. This means that many people have mortgages and, as such, changes in interest rates (to control inflation) can artificially increase the prime rate. Causes of Inflation There are two main causes of inflation, 1) Inflation attracting demand. This is where the total demand for goods and services in the economy exceeds the total supply. This happens after excessive growth in aggregate demand and creates an inflationary gap. Excess demand in the economy drives up prices, and high prices mean that suppliers want to produce more units of their product to make more money. To deliver more, they need to increase their production capacity, and the easiest way to do this in the short run is to increase the amount of labor they employ. This means they pay more wages, so people will have more disposable income and therefore there is more demand in the economy. Demand-pull inflation is often monetary in origin: when the money supply grows faster than the economy's supply capacity. goods and services. This concept is explained by the Quantitative Theory of Money. The quantity theory of money holds that changes in the general price level are directly proportional to changes in the quantity of money. It is obvious, however, that a simple increase in supply would have no effect on prices. For this to happen, the increase will have to be spent. This is where circulation velocity (V) becomes important. If the total amount of all transactions is T and the total amount of money is...... half of the card ......sion (i.e. unemployment) are they delayed? they don't respond until the damage has been done, and so, in the Lawson Boom example, because consumer demand did not respond quickly to interest rate increases, rates were raised too much, which stifled the growth instead of simply slowing it down. Some now suggest that the boom-and-bust cycle ended with the advent of e-commerce, as more and more companies employ fewer and fewer people and are much more responsive to changes in demand. There is some empirical evidence to suggest this, as inflation appears to have been fairly constant in recent years (see appendix 2). However, whether this is due to electronic trading, the Bank of England's semi-autonomous control of interest rates, or some other factor has yet to be discovered. Bibliography Introduction to Economics - GF Stanlake Chapter 11 Principles of Economics? Lipsey and Chrystal Chapters 26-32Macroeconomics ? Greenaway and Shaw www.tutor2u.net ? statistics on inflation, income and unemploymentwww.answersleuth.com/numbers/1970.shmtl ? oil price history www.thebankofengland.co.uk -The Bank of England ? interest rate statistics