Inertial inflation
Encyclopedia
Inertial inflation is a concept coined by structuralist inflation theorists. It refers to a situation where all price
s in an economy
are continuously adjusted with relation to a price index
by force of contract
s.
Changes in price indices trigger changes in prices of goods. Contracts are made to accommodate this price-changing scenario by means of indexation
. Indexation
in a high-inflation economy
is evident when, for instance, a given price must be recalculated at a later date, incorporating inflation accumulated over the period to "correct" the price. In other cases, local currency prices can be expressed in terms of a foreign currency. At some point in the future, prices are converted back from the foreign currency equivalent into local currency. This conversion from a "stronger" currency equivalent value (ie, the foreign currency) is intended to protect the real value of goods, as the nominal value depreciates.
In the medium-to-long term, economic agents begin to forecast inflation
and to use those forecasts as de facto
price indexes that can trigger price adjustments before the actual price indices
are made known to the public. This cycle of forecast-price adjustment-forecast closes itself in the form of a feedback loop and inflation indices get beyond control since current inflation becomes the basis for future inflation (more formally, economic agents start to adjust prices solely based on their expectations of future inflation). At worst, inflation tends to grow exponentially (leading to hyperinflation
).
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...
s in an economy
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
are continuously adjusted with relation to a price index
Price index
A price index is a normalized average of prices for a given class of goods or services in a given region, during a given interval of time...
by force of contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
s.
Changes in price indices trigger changes in prices of goods. Contracts are made to accommodate this price-changing scenario by means of indexation
Indexation
Indexation is a technique to adjust income payments by means of a price index, in order to maintain the purchasing power of the public after inflation....
. Indexation
Indexation
Indexation is a technique to adjust income payments by means of a price index, in order to maintain the purchasing power of the public after inflation....
in a high-inflation economy
Economic system
An economic system is the combination of the various agencies, entities that provide the economic structure that defines the social community. These agencies are joined by lines of trade and exchange along which goods, money etc. are continuously flowing. An example of such a system for a closed...
is evident when, for instance, a given price must be recalculated at a later date, incorporating inflation accumulated over the period to "correct" the price. In other cases, local currency prices can be expressed in terms of a foreign currency. At some point in the future, prices are converted back from the foreign currency equivalent into local currency. This conversion from a "stronger" currency equivalent value (ie, the foreign currency) is intended to protect the real value of goods, as the nominal value depreciates.
In the medium-to-long term, economic agents begin to forecast inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
and to use those forecasts as de facto
De facto
De facto is a Latin expression that means "concerning fact." In law, it often means "in practice but not necessarily ordained by law" or "in practice or actuality, but not officially established." It is commonly used in contrast to de jure when referring to matters of law, governance, or...
price indexes that can trigger price adjustments before the actual price indices
Price index
A price index is a normalized average of prices for a given class of goods or services in a given region, during a given interval of time...
are made known to the public. This cycle of forecast-price adjustment-forecast closes itself in the form of a feedback loop and inflation indices get beyond control since current inflation becomes the basis for future inflation (more formally, economic agents start to adjust prices solely based on their expectations of future inflation). At worst, inflation tends to grow exponentially (leading to hyperinflation
Hyperinflation
In economics, hyperinflation is inflation that is very high or out of control. While the real values of the specific economic items generally stay the same in terms of relatively stable foreign currencies, in hyperinflationary conditions the general price level within a specific economy increases...
).
See also
- 1972 Chile is an example of another positive feedbackPositive feedbackPositive feedback is a process in which the effects of a small disturbance on a system include an increase in the magnitude of the perturbation. That is, A produces more of B which in turn produces more of A. In contrast, a system that responds to a perturbation in a way that reduces its effect is...
mechanism in inflation, through the fiscal deficit/black economy channel - HyperinflationHyperinflationIn economics, hyperinflation is inflation that is very high or out of control. While the real values of the specific economic items generally stay the same in terms of relatively stable foreign currencies, in hyperinflationary conditions the general price level within a specific economy increases...
has an overview of uncontrollable inflation causes.
External links
- http://www.swlearning.com/economics/econ_data/money_supply/money_supply_update.html Excerpts from a speech given by Federal Reserve Governor Ben S. Bernanke on indexation and structuralism.
- http://bresserpereira.org.br/ver_file.asp?id=217 A paper by former BrazilBrazilBrazil , officially the Federative Republic of Brazil , is the largest country in South America. It is the world's fifth largest country, both by geographical area and by population with over 192 million people...
ian Minister of Finances Luiz Carlos Bresser Pereira on the developments of the inertial inflation theory by Brazilian economists and the theoretical basis of the Plano Cruzado. While "Structural inflation" gives a monetary policyMonetary policyMonetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
cause for inflation, the "Structuralism" school argues that non-monetary causes dominate.