This lesson explains why the public often fears inflation more strongly than economists do. It introduces the difference between changes in money amounts and changes in real purchasing power.
Economists generally oppose high inflation, but their concern is often milder than that of the general public. In surveys conducted during the 1990s, Robert Shiller asked whether preventing high inflation was as important a national priority as preventing drug use or deterioration in schools. Respondents rated their agreement on a scale from 1, “Fully agree,” to 5, “Completely disagree.”
All flashcards
How do nominal and real values differ?
Nominal values are expressed in money units; real values reflect what those amounts can buy.
What happens to purchasing power when prices rise but cash holdings do not?
The cash buys fewer goods and services, so its purchasing power falls.
Why can taxing nominal interest reduce an investor’s real return?
Tax may be charged on interest that only compensates for inflation, even if real purchasing power has not increased.
What does it mean for wages to be sticky?
Wages do not adjust immediately when economic conditions or prices change.
How can high or variable inflation weaken price signals?
It can obscure whether a particular price change reflects market-specific supply or demand, or a general rise in prices.
Quiz questions
What did Robert Shiller’s surveys indicate about public concern over preventing high inflation?Answer: A greater share of the public than of professional economists fully agreed it was a highly important priority.
Why can an investor owe tax on interest without gaining purchasing power?Answer: Tax may apply to nominal interest even when inflation offsets the interest’s real value.
Why can buyers have difficulty interpreting a product’s price increase during high, variable inflation?Answer: The increase may reflect a general rise in prices rather than a change in that product’s market.
When can inflation benefit a borrower with a fixed-rate loan at the lender’s expense?Answer: When inflation exceeds what was expected when the loan’s nominal interest rate was set.
How might modest inflation help a labor market when nominal wages are sticky downward?Answer: It can lower real wages without requiring employers to cut nominal wages.
Based on Principles of Economics 3e by Steven A. Greenlaw, David Shapiro, Daniel MacDonald (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.