Inflation: from price noise to macro strategy
Inflation is a sustained movement in the general price level. Olympiad answers win when you name the mechanism, the index, and the policy trade-off.
What inflation measures
Inflation rate π ≈ (Pt − Pt−1) / Pt−1. Deflation is negative inflation; disinflation means inflation is positive but falling.
Separate a one-time shock from ongoing inflation driven by wage indexation and expectations.
CPI, GDP deflator, core
CPI — consumer basket. GDP deflator — domestic output prices. Core — excludes volatile food and energy.
Implicit deflator = Nominal GDP / Real GDP × 100. Do not mix indices without justification.
Demand-pull, cost-push, built-in
Demand-pull: AD shifts right. Cost-push: SRAS shifts left (stagflation risk). Built-in: past inflation feeds wage demands and prices.
Expected vs unexpected
Unexpected inflation redistributes wealth and distorts relative prices. Fisher: nominal rate ≈ real rate + expected π.
Central bank response
Tighter money reduces demand but raises unemployment risk. Mention recognition, implementation, and effect lags.
Checklist
- Relative price ≠ inflation without a general index.
- Label AD-AS shifts and new equilibrium.
- Connect to Phillips curve when labor markets appear.