INFLATION

inflationA persistent rise in the general level of prices.

disinflationA falling inflation rate.

zero inflationNo change in the general level of prices.

hyperinflationA rapidly rising inflation rate, often reaching hundreds of percentage points within a few months.

deflationThe opposite of inflation, in which the general level of prices declines.

stagflationA simultaneous increase in both the inflation rate and the unemployment rate.

purchasing power of moneyThe amount of goods and services a unit of money can command in the market.

price index A numerical device used to measure changes in prices.

consumer price indexA measure of inflation based on a theoretical market basket of consumer goods.

Everyone is familiar with the way prices of goods and services behave in the mar­ketplace. They usually go up. The phenomenon of rising prices is calledinflation.Since the economy includes multitudes of prices, and all do not rise or fall at the same time, it is convenient to use the concept of an average price and describe inflation as a continuing rise in the level of the average price, or the general price level.

The inflation rate is the rate of change (or the percentage change) in the general price level over a specified time period, usually a year. An increase in the inflation rate means that prices are rising at a faster rate. A decrease in the inflation rate means that prices in general are not rising as quickly as before; it does not mean that prices are falling. The termdisinflation is often used to describe a declining inflation rate. If prices in general do not change, a situa­tion ofzero inflationexists.

Rapidly rising prices may lead to a situation called hyperinflation. Many countries have experienced hyperinflation, some very recently, with inflation rates reaching hundreds of percentage points in a matter of months.

The phenomenon of falling prices is known as deflation. It is the opposite of inflation.

Economies have also experienced a situation known asstagflation. This occurs when a high rate of inflation is accompanied by a high level of unemployment This presents a dilemma for policy makers, as attempts to cure one problem invariably make the other one worse. The cherished goal of every country has been to keep both problems under control to avoid the heavy costs they inflict on people.

Inflation and thepurchasing power of money are inversely related. Inflation causes the purchasing power of money to fall. The purchasing power of money (also known as the value of money) is the amount of goods and services that one unit of money can buy. When prices rise, the same goods cost more in terms of dollars, and the dollar's value in terms of those goods falls.

Inflation is commonly measured with the aid of aprice index. A price index is a statistical device to measure price changes between a base period and a subse­quent period. Economists use many different price indices. Theconsumer price index (CPI) is the most popular index for tracking inflation in the United States. The CPI measures the average change in the prices paid by urban consumers for a fixed basket of goods and services. The statistics for this index are compiled by the Bureau of Labor Statistics of the U.S. Department of Labor, which publishes them monthly.

1. Sum up the text in 7-10 sentences and present your summary in class. Use the key-words given before the text.

T E X T 7

EXCHANGE RATE

When residents of one country trade with residents of another country, they must generally convert funds between the currencies of the two countries to facilitate payments. Currency conversion requires a rate to define the value of one curren­cy in terms of another currency. This rate is theexchange rate.

Since multinational companies trade in many different foreign markets, that’s why portions of their revenues and costs are based on foreign currencies. Among the currencies regarded as being major (or ‘Hard’) are the British pound, the Swiss franc, the Deutsche mark, the French franc, the Japanese yen, the Canadian dollar and the US dollar. The value of two currencies with respect to each other is foreign exchange rate.

For the major currencies, the existence of a floating relationship means that the value of any two currencies with respect to each other is allowed to fluctuate on a daily basis. On the other hand, many of the nonmajor currencies of the world try to maintain a fixed (or semi-fixed) relationship with the respect to one of the major currencies, or some type of an international foreign exchange standard.

On any given day, the relationship between two of the major currencies will contain two sets of the figures, one reflecting the spot exchange rate (the rate on the date), and the other indicating the forward exchange rate (the rate at some specified future date).

Two widely used systems of quoting exchange rates are known asEuropean terms andAmerican terms of quotation. In European terms, the value of the U.S dollar is expressed in terms of all other currencies. In American terms, the values of all foreign currencies are expressed in terms of U.S. dollars. American terms of quotation are commonly used in many retail currency transactions. In their dealings among themselves, banks use European terms of quotation except for quotes on the British pound, the Irish punt, the Australian dollar, and the New Zealand dollar. These currencies have been traditionally quoted in American terms. The Wall Street Journal reports daily exchange rates in both European terms and American terms.

Exchange rates between pairs of currencies that do not involve the U.S. dollar such as the rate between the German mark and the Swiss franc, are known ascross rates. The common practice of quoting exchange rates in either European or American terms requires an additional calculation to obtain cross rates from these quotations.

Consider the following quotes (in European terms) of Deutschemarks and Swiss francs against the U.S. dollar:

DM1.6240/$ and SF1.4625/$

The cross rate of the DM against the SF is obtained by dividing the DM/$ rate by the SF/$ rate, as shown below:

DM/SF = (DM/$)/(SF/$) = 1.6240/1.4625 = DM1.1104/SF

This cross rate indicates that one Swiss franc is worth 1.1104 Deutschemarks.

1. What is exchange rate?

2. What are ‘hard’ currencies?

3. What does a floating relationship mean?

4. What are cross rates?

T E X T 8