MacroeconomicsLesson 5 of 5 in the course Inflation

Inflation Indexing: Uses, Uneven Protection, and Economic Effects

5 flashcards · 4 quiz questions · 5 match pairs · 5 fill-in sentences · English

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Summary

Indexing links a payment, price, wage, or other amount to an inflation measure. This lesson explains how indexing can protect people and organizations from unexpected changes in the purchasing power of money.

When a price, wage, or interest rate is adjusted automatically according to an inflation index, it is indexed. An indexed payment changes as the relevant index changes. Because inflation can raise prices without raising every person’s income, it may reduce someone’s purchasing power or redistribute resources unexpectedly. Indexing can reduce this effect by linking selected payments or rates to inflation.

All flashcards

Indexing
Automatically adjusting a specified amount according to an inflation measure.
Cost-of-living adjustment (COLA)
A wage or benefit increase linked to inflation.
Bracket creep
When inflation-driven nominal income growth moves someone into a higher tax bracket without increasing real income.
Adjustable-rate mortgage (ARM)
A home loan whose interest rate varies according to specified conditions.
Indexed bond
A bond whose returns adjust with inflation and include a stated real yield.

Quiz questions

  1. A wage contract promises inflation plus 3%. What raise does it provide when inflation is 5%?Answer: An 8% raise.
  2. How can an inflation-adjusted price clause benefit both parties to a long-term business contract?Answer: It reduces the risk that the agreed nominal price becomes unsuitable when inflation differs from expectations.
  3. What happens when income-tax thresholds are indexed to inflation?Answer: The income levels at which higher tax rates begin rise with inflation.
  4. What was the central disagreement among economists about pandemic-era inflation in 2021?Answer: Whether price increases were a temporary adjustment or evidence of persistent inflation.

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.

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