Inflation and Deflation Processes - Assignment Example

Macro Economics Table of Contents Table of Contents 2 Question 3 Introduction 3 Below Target Inflation 4 Consequences of Low rate of Inflation 5 Concerns for Deflation or Disinflation 6 Macroeconomic Tools & Side Effects 8 Conclusion 10 Question 2 11 Introduction 11 Four Key Macroeconomic Variables 11 Real GDP 12 Unemployment 12 Inflation Rate 13 Interest Rates 13 Influence of the Macroeconomic Variables 14 Objectives of the UK Government 16 Conclusion 17 References 19 Question 1 Introduction Inflation and deflation are the most important parts of an economy that help in determining the fiscal and monetary policies predominant within an organisation. Inflation and deflation are the determining terms of the national incomes and help in estimating the measures of the Gross Domestic Products (GDP) of an economy. It is even noted that inflation as well as deflation affects the overall economy of a nation and leads to adverse situations for a country. The increase and decrease of the value of money leads to adverse situations and has a huge impact on the overall economy. High rates of inflation affect the output of the economy and influence the growth of the economy. A permanent or long lasting inflation shock affects the economy on a larger note. On the other hand, the continuous rate of deflation leads to a persistent decline of prices and affects the economy at large1;2. With this regard, the assignment elaborates the present issue of euro zone with respect to the below target inflation rate. The different consequences that may arise due to deflation have been elaborated in the paper. Furthermore, the different macroeconomic tools that are available to avoid such side effects have been detailed. Below Target Inflation Inflation rates that are prevalent within a country help in determining the different monetary policies important within an economy. Inflation rates help in determining various conceptions predominant for determining monetary policies of a nation. The monetary policies guide in developing different economic frameworks to be determined within an economy. The below target of inflation affects the economy on a whole and has a major impact on the output of a nation. The long run inflation targets are one of the major issues that help in determining the different economic operations of a nation. Inflation rates that are operating in a nation determine the interest rates and the value of money at large. Inflation rates can never be zero, as this would be highly unrealistic and would lead to a larger fall in the value of money within the economy. Both continuous rise and fall in the rate of inflation has adverse effects on overall economy of a nation. Below target inflation, for a continuous rate may lead to a steep fall in GDP and even lead to a fall in the value of money3;4. With the above mentioned concepts, the below target inflation rate in the Eurozone has been lower than the estimated rate of inflation for a given tenure. This is even noted that the specific monetary as well as fiscal policies that are predominant within the region create a low rate of inflation within the region for a specific term. This is further noted that low rate of inflation leads to a fall in the process and affects the overall economy of the zone. This continuous fall in the prices of the region owing to substantiate low rate of inflation can lead to deflation in the near future. The continuous fall in the inflation rate in the Eurozone may lead to the risk of deflation within the region during the recent years. This is even noted that the interest rates are falling over the years due to this continuous fall in the rate of inflation. This below target rate of inflation is even creating an aggressive attitude towards the prices that may affect the future development of different economies5;6. Consequences of Low rate of Inflation Inflation is a determining factor that helps in developing a clear relationship with the different financial transactions that are incorporated within the Eurozone. The low rate of inflation even creates an impact on the interest rates that are charged by the bank. The rate of growth of inflation is directly proportional to the nominal rate of inflation. The low rates of inflation for a longer tenure even have an impact on the growth of the economy. This even hampers the sluggish growth of the overall economy and has a direct impact on the rate of real level of debt. This modest growth of the overall rate of inflation in the recent years may even lead to the fragile recovery from the existing condition of the economy. This may create a huge impact on the business that is operating within the region. The continuous stagnant and low rate of inflation may lead to a severe fall in the business transactions and may even affect the overall growth in the rate of GDP. This may even be crucial for an economy to sustain the competitive domain that is prevalent within the economy7;8. A continuous low rate of inflation can affect different operations that are taking place within the economy. This may even hamper different businesses operating within the economy. For instance, the sluggish growth of the economy and the continuous low rate of inflation can affect business transactions at large9. With the stagnant growth of the economy, there are high chances that the business entities will be looking for external options for investment. This may even be noted that the region will be facing a situation of disinvestment and even create a rundown of business. This will even lead to an adverse impact on different economic transactions and develop the concepts of financial transactions. The rigidity in the financial system would even create severe crises and hamper the opportunities that are prevalent for a business10. Concerns for Deflation or Disinflation The continuous low rate of inflation is even likely to have an impact on the economic development of the Eurozone. This is even noted that the low rate of inflation is even going to create a huge risk on the opportunities that are likely to be created within the region. This divergence in the existing economic system creates a gap in the existing economic operations. This even creates an impact on the different nominal disposable incomes projected to arise at a faster rate11. The investment that is prevalent within the country is even going to have an impact on the investment structure. The continuous below target level of inflation can lead to severe amounts of effect on the Consumer Price Index (CPI). In this context, it is noted that a lower rate of inflation or deflation may lead to be crucial than the increasing rate of inflation. This is even noted that the rate of debts that are prevalent within an economy is severely affected by the falling rate of inflation or deflation12. The major concerns for the disinflation are that it is affecting the overall economy to a greater extent. It is recognised that with the falling rate of credits and different interest rates are having a huge impact on the the operations of the overall economy. With the continuous rate of disinflation, the government spending has been also adding up. This trend has been affecting the overall operation of the economy. The fiscal consolidation is having a severe impact on the debt ratios and has a huge influence on the economic activity that is being undertaken within the region. The different economic activities are also hampered with the disinflation for the longer term. The different operations that are undertaken by the different financial institutions are observed to be highly affected by the economic transactions within the region. Furthermore, different debt crisis is affecting the rate of employment within the nation and has even been affecting the operations of the economy at large13. Macroeconomic Tools & Side Effects The disinflation rates prevalent within the economy of Eurozone affect the development of the different economic concerns that may lead to severity of situations. Macroeconomic tools, which may enhance the present condition of the economy is majorly related to the financial intermediation. The different interventions of the monetary policies may increase the present situation of the rigid nominal inputs. The immediate rectification of the nominal rate of real inputs will develop from the fall in the rate of wages and other prices within the economy14. The continuous rate of disinflation leads to stagnation of the economy and creates a huge influence on the different economic activities within an economy. The central banks of the Eurozone are even effectively incorporating a diversified rate of interest. This is even likely to develop the monetary and fiscal policies that are prevalent within the region to prevent the liquidity trap that is projected due to the disinflation within the central bank. To prevent such measures, the central banks opt for quantitative easing and decrease the money supply. This can lead to a crisis within the region and can start increasing the rate of inflation in the future15. Conversely, the effective implication of the tools may lead to a huge amount of adversity within the economy. The adjustments that are to be incorporated within the economy can even lead to negative instances. These adjustments are brought into the system to ease out different economic circumstances that need to be monitored and changed at a continuous basis. The flow of money needs to be controlled at several instances to create a balance in the economic circumstances16. These imbalances even create a huge influence on the economic decision that is undertaken by the government17. Correspondingly, at several instances, the different macroeconomic concepts are identified to be highly affected by the use of different tools to stabilise the economy. Certain steps to be incorporated with the use of different tools in order to enhance the macroeconomic concepts would efficiently develop the economy from its position of disinflation. However, this may even lead to a sequence of higher inflation rates. On a larger note, the different tools may not be efficient enough to increase the low inflation rate within the economy18. The increase in the quantitative commercialisation within the economy having major side effects could not be nullified. Since, different collateral wealth is used for developing the economic conditions, the same could even lead to development of collateral loans. These situations of massive investments may lead to an episode of quick boost in the real estate prices and finally create a huge bubble in the housing sector. Furthermore, there can be an unexpected rise in the demand that may affect the different policies and further develop an intensive rate of inflation. The different policies that are undertaken by the government developed from the economic crisis disinflation can often lead to severe situations of inflation and affect the interest rates of the economy19. Several complexities may affect the trade off between the anticipation of the systematic risk and further create an adverse situation within the economy. The macro prudential responsibilities of the different financial institutions are even likely to affect the foreign exchange intervention. There are certain provisions for the liquidity that if extended may lead to severity of situations. Accordingly, these provisions create a positive addition on the financial expenditure of the government and increase tax cuts. This phenomenon may also increase the interest rate sensitivity and hamper the different economic projections20. Conclusion The Eurozone is facing severe amount of down turn in the recent years and is even undergoing enormous amount of disinflation for a long term. This long-term disinflation is even likely to affect the economic growth of the country and further create a huge amount of backlog in the economic condition. This may even directly affect GDP growth and income stability within an organisation. This is even noted that the tax revenues and interest rates are highly affected by the inflation rates. In addition, the equity structures within an economy are even affected by the disinflation rate. The continuous rate of disinflation creates a severe fall in the price of the products and creates a liquidity trap within the economy. Thus, a consecutive long term of disinflation may lead the economy into a state of deflation. Correspondingly, the continuous low rate of inflation would lead to a situation that may tend towards zero. This continuous rate of disinflation would even lead to a tendency of the economy to fall below the zero bound and create an impact on the overall progress of the economic system. Question 2 Introduction Macroeconomics refers to a country’s economic structure as well as the analysis of the government policies affecting the economic conditions. Furthermore, the economic structure is a determinant factor that affects the standard of living of the commoners residing within an economy. Several factors affect the economic structure of a nation and the economic growth and fall. Majorly all economic system faces a decline and rise during operation. Macroeconomic variables act as a trade off between the different decline and growth of an economy as a whole. Since, macroeconomics deals with the aggregate variables such as purchasing power, price and money of the overall variables, the improper analysis of the same can lead to adverse situation within an economy21. In this regard, the report analyses the different macroeconomic variables that affects the pecuniary development of an economy. Furthermore, the report even elaborates the different measures undertaken by the UK government to influence these variables to fulfil the government objectives. Four Key Macroeconomic Variables Macroeconomics constitutes four important variables that determine the economic health of a nation broadly classified as real GDP, interest rate, unemployment as well as inflation rate. These four variables affect the health of an economy and even influence the different economic activities that are operating within a nation22. The four variables that determine the macroeconomic concepts have been described as follows: Real GDP The real output refers to the product that are sold from an economy during a fiscal year that would earn a stipulated income. This even refers to the amount of income from the sale determined within a GDP. The real output of a nation helps in determining the income level of an economy and enhances the ability of the economy to perform. The continuous movement of the GDP rate affects the overall rise and fall in the prices of the commodities. The real GDP is not affected by the changes in price of a commodity, but is dependent on the overall change in quantity. Hence, it helps in determining the prices of the products as well as services that are produced within an economy23. Unemployment The exogenous shocks directly affect the different macroeconomic variables that are operating within an economy. The different economic policies and downturn has a long-term effect on the rate of unemployment within an economy. The rate of unemployment is directly proportional to the economic growth within an economy. The macroeconomic variables constitute different long-term impacts on the level of unemployment within an economy. Unemployment rate of a country refers to the labour development that is prevalent within an economy. The rate of unemployment prevalent within an economy creates an impact on the macroeconomic performance of the economy. The rate of unemployment has a huge impact on the different performances that are prevalent within an economy and enhances the performances of the economy as a whole24. Inflation Rate The inflation rate of a country is one of the most important macroeconomic variables that have an influence on the development of an economy of a nation. Increasing rate of inflation creates severe situations leading to the increase in the price of products and services within an economy. The inflation rate determines ability of an economy to flourish. These factors even determine the rate of growth that an economy undergoes. However, the rate of growth and fall of inflation creates a huge impact on the overall development of an economy. Continuous disinflation can lead to a massive downturn of economic growth and further affects performances of economic factors within an economy. Inflation rates that are predominant within an economy create a positive impact on the economic growth of a nation25. Interest Rates Interest rates are one of the major players of an economy. This is an important variable of macroeconomics, which helps in developing equilibrium among the economic components. The interest rate that is prevalent within an economy enhances the performance of the economy and develops a better growth prospect for an economy in future. The interest rates acts as an effective tool that helps in controlling the money market and the other financial operations such as lending and borrowing. Interest rates are even determining factors that help in valuing the different assets used for transaction within an economy. Furthermore, the interest rates aid in having a better control of an economy on the nominal money supply and develop a better control on the aggregate variables operating within an economy26. Influence of the Macroeconomic Variables The economic performances of the UK have not been favourable since 2008-09 during the post-recession era. This is even having an impact on the different debt instruments that are available within the economy. The UK government is effectively monitoring the GDP rates and have been adjusting the seasonal GDPs in an effective manner. This is further developing the related estimates and enhances the output gaps. This enhances the ability of the government to identify the output gaps and helps in estimating the quarterly operations of an economy27. The following diagram illustrates that the GDP rate has been falling drastically during the recession period. However, due to government intervention, the same has started developing at a stable rate in the recent years28. Fig: Real GDP Source: 29 Unemployment rate has been identified to be declining in the recent years post recession. The rate of unemployment has been falling at a steep rate during the recent years and is having an impact on the microeconomic factors. The different policies included by the government are effectively supporting the rate of employment and reducing the level of unemployment. To reduce the rate of unemployment, the government organisations are tactically including the different pensions and even the government organisations opted for pay cuts. This strategic development effectively reduces the number of youth undergoing absolute unemployment30. The UK government has been successfully maintaining the rates of GDP and inflation rates. The different monetary policies that are prevalent within the economy are leading to proper anticipation of the output gaps. The flexible policies enhance the credibility of the market and develop a better approach towards the maintenance of the different financial rates that are prevalent within the market, as the inflation rates are directly proportional to the interest rates that are prevalent within the economy. The UK government has been maintaining inflation as well as interest rates in an efficient manner, so that a financial stability of the risks could be attained. In order to maintain a low rate of inflation, the UK government has been effectively maintaining a low rate of Gilt fund. This helps the government to safeguard financial stability from the premium risks that are observed at the time of high inflation31. Objectives of the UK Government The UK government post-recession majorly focused on the development of the labour market. With the objective to boost the trade performances, the UK government is inclined on redesigning the overall macroeconomic system. Furthermore, the government have been developing the level of employment to provide a stable economic situation. The government even plans to maintain a stable and low rate of inflation at 2.0% for the Consumer Price Index (CPI). Furthermore, the UK government plans to maintain a sustainable GDP, so that they can maintain a sustainable growth in an economy32;33. With the objective to maintain the price stability, the UK government maintains a low rate of inflation. This sustainable domain helps the government to maintain economic stability and less fluctuation in the Consumer Price Index (CPI). With the development of a credible plan to tackle the economic operations, the government has been effectively managing the fiscal deficit. In this context, handling financial transactions has effectively enhanced the ability of the economy to perform better. The major objective that has catalyst the development of the UK government’s economic plan is to develop the UK as the best place in Europe for financial investment. With the development of a balanced economy, the government can effectively maintain the operations and further enhance the trade and commerce across border. The government even projects a competitive plan to enhance business across border and develop a low tax rate. With the maintenance of a low rate of inflation, the country has been effectively planning for building competitive edge and enhancing business and commerce34. Conclusion The different macroeconomic factors enhance the credibility of the performances of an economy. The elements involved in the macroeconomic system help in developing a long-term plan for the performance of an economy. The evaluation of the variables helps in developing a macroeconomic stability within an economy and initiates economic growth. Nurturing the different factors that are involved with the macroeconomic operations help in determining the different policies involved in developing the economic system of the UK. The macroeconomic variables are duly influenced by the UK government to develop a stable economic system. This even develops the ability of the economy to face the unpredictable economic shocks. 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