The Phillips curve helps to explain the link between inflation and the state of the economy. In general, the Phillips curve suggests that inflation is relatively high when the economy is strong and the unemployment rate is low, and inflation is relatively low when the economy is weak and the unemployment rate is high. However, economic conditions are only one of the factors that determine inflation.
For these reasons, inflation may not always be tightly connected to economic conditions and the ups and downs of the business cycle. The Phillips curve is named after economist A. Phillips, who initially identified the relationship between unemployment and wage inflation in the United Kingdom, and subsequent work extended the idea to inflation as measured by prices as well. When inflation is extremely high and typically accelerating prices are rising rapidly and generally at an increasing pace , an economy experiences hyperinflation , which is usually associated with or can cause social upheaval and civil unrest.
More recent examples include Venezuela starting in , Zimbabwe in the s, and Yugoslavia in the s. One common definition of hyperinflation is when inflation is more than 50 percent per month. In some extreme cases, hyperinflation can be so intense that prices double within a matter of days.
While inflation imposes costs on a society, the opposite scenario, deflation —when the overall price level falls for a sustained period of time—can be costly, too. If people think prices will go down in the future, they have less incentive to spend their income now. Disinflation refers to a slowdown in the inflation rate, as would be the case if the inflation rate moves from 6 percent to 4 percent. The overall price level is still rising, but at a slower pace than before.
While the Phillips curve posits that high inflation tends to occur alongside a strong economy and low unemployment, stagflation refers to the combination of relatively high inflation and a very weak economy.
The US experienced two bouts of stagflation during the —75 and recessions, when inflation as measured by the year-over-year change in the CPI was above 10 percent even as the unemployment rate was rapidly rising. Want to keep reading? Learn why you should care about inflation. Toggle navigation Menu. What Is Inflation? Get started Get technical How do you measure inflation?
Why are there so many different price indexes and measures of inflation? Prices of fruit, vegetables and fuel are usually very volatile because they are often affected by supply disruptions, such as unusual weather, or changes in how much oil is supplied to the world market. The CPI excluding volatile items always removes the same items, while the items that are removed from the trimmed mean and weighted median can change each quarter, depending on which items had particularly large price changes.
To calculate the trimmed mean and the weighted median, all 87 items are ordered by their quarterly, seasonally adjusted price change. Seasonal adjustment means that price changes have been adjusted for increases or decreases that always occur at a particular time of year; for example, high school fees typically increase in the March quarter, so an adjustment is made to spread this out over the year.
It is the weighted average of the middle 70 per cent of items. Weighted median is the inflation rate of the item at the middle of the price changes in the CPI basket the 50th percentile by weight. The CPI measures the rate of price changes in the economy, but not the price level.
If the price index of bread is and the price index of eggs is , it does not mean that eggs are more expensive than bread. It only means that the price of eggs has increased by more than the price of bread from a particular point in time. For practical reasons, the CPI measures price changes of items in the metropolitan areas of Australia's eight capital cities where around twothirds of Australian households live.
It does not measure price changes in regional, rural or remote areas. The CPI also does not take into account the differences in spending patterns between individual households. Households are very different and some may spend a lot more on a certain items than others. For example, cars have a weight of almost 3 per cent in the CPI basket, but not every household owns a car. The CPI intends to only calculate pure price changes.
This means the CPI should ignore price changes that result from variations in the quality of items. The quality of items in the basket can vary and new products can be introduced. For example, a bag of pasta can become smaller in weight, or the quality of a mobile phone can improve if its camera is upgraded. The ABS tries to remove any price changes that result from changes in quality or the mix of items that households buy. Continuing with the previous examples, the ABS would calculate the price of the pasta assuming that the weight remained the same, and compare it with the price in the previous quarter.
Calculating the increase in the price of a mobile phone due to the improved camera is more difficult, because there is often limited information about how much the price of the phone has changed because of the better camera. Our emails are made to shine in your inbox, with something fresh every morning, afternoon, and weekend. The basket is divided into broad categories that are common across countries: food, for instance, or transport, or healthcare, or clothing. Each item and category is weighted, to show how much of an average household budget is spent for those goods and services—to show, essentially, what the cost of living is.
This is where things become interesting. The differing weights reflect many things: cultural patterns, for instance, or levels of economic development. A country may tinker with the weights assigned to categories as well, to reflect changes in spending habits or the economy over time. The US and the UK review their baskets and the weights of categories once a year.
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