ECON 101 · Macroeconomics

In-
flation

A sustained rise in the general price level — and one of the central preoccupations of macroeconomic policy in every generation.

Prof. Muhebullah Karimzada · UNBC Economics

Prices & Measurement

A sustained rise in the general price level.

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Consumer Price Index

Statistics Canada measures inflation via the CPI — the cost of a representative basket of goods and services (food, shelter, transport, healthcare) purchased by a typical household.

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Inflation Rate

The percentage change in the CPI from one period to the next. If CPI rises from 120 to 123.6, inflation is 3%.

π = (CPI₁ − CPI₀) ÷ CPI₀ × 100

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Real vs. Nominal

Inflation distinguishes nominal values (in current dollars) from real values (adjusted for inflation). Real GDP, real wages, and real interest rates all account for the eroding effect of rising prices.

Three Causes of Inflation

Inflation can be driven by demand, supply, or expectations — and the appropriate policy response depends on knowing which is at work.

Demand-Pull "Too much money chasing too few goods." When aggregate demand rises faster than supply capacity, firms respond by raising prices. The AD curve shifts right, driving up the price level.

Cost-Push Rising production costs — a spike in oil prices, higher wages, or supply-chain disruptions — shift the SRAS curve leftward, reducing output while raising prices simultaneously.

Built-In A wage-price spiral: workers demand higher wages expecting future inflation; firms pass higher costs on as higher prices; which triggers further wage demands. Self-fulfilling and hard to break.

The Costs of Inflation

Inflation's most visible cost is the erosion of purchasing power — the real value of every dollar held falls each year. But it also creates a web of hidden inefficiencies.

2% / yr At Canada's 2% target, $100 today buys only $67 worth of goods in 20 years. Manageable — and predictable enough to plan around.

5% / yr Purchasing power falls to $38 in 20 years. Savers and fixed-income earners suffer significant real wealth loss. Investment and long-term planning are disrupted.

10% / yr Only $15 remains in 20 years. High, volatile inflation destroys savings, deters investment, and erodes trust in the monetary system. Menu costs and shoe-leather costs multiply.

Key Unpredictability is as damaging as the level. Even moderate inflation, if volatile and unexpected, distorts economic decisions and imposes large costs on businesses and households.

Winners & Losers from Inflation

Inflation redistributes wealth — from creditors to debtors, from savers to borrowers. This arbitrary redistribution is one of the strongest arguments for keeping inflation low and stable.

Winners

✓ Debtors & Asset Holders

Borrowers repay loans in cheaper dollars — the real burden of debt falls as prices rise. Homeowners with fixed-rate mortgages benefit. Owners of real estate, equities, and commodities see nominal asset values rise.

A $300,000 fixed-rate mortgage shrinks in real terms every year inflation runs above zero.

Losers

✗ Savers & Fixed-Income Earners

The real return on savings accounts and bonds falls. Pensioners and retirees on fixed incomes see purchasing power erode steadily. Cash holders lose real wealth directly — inflation is a tax on money.

Hyperinflation (Zimbabwe 2008, Venezuela 2018) can wipe out all savings within months.

Why target 2%? Low, stable inflation preserves savings, supports long-run planning, and avoids the deflation trap — where falling prices cause consumers to delay spending, deepening recessions.

The Policy Toolkit

Fighting Inflation

The Bank of Canada targets 2% inflation — the midpoint of a 1–3% control range. When inflation deviates from target, policy responds to bring it back.

Rate ↑ When inflation is above target, the Bank raises the overnight rate. Borrowing becomes costlier → investment and consumption fall → aggregate demand cools → prices stabilise.

Rate ↓ When inflation is below target (or deflation threatens), the Bank cuts rates to stimulate demand and push inflation back up toward 2%.

Expectations Anchoring inflation expectations is itself a policy tool. When households and firms believe inflation will stay near 2%, they set wages and prices accordingly — making the target self-fulfilling.

Monetary Policy

Raise overnight rate to cool demand and bring inflation down

Lower overnight rate to stimulate demand and push inflation up

Primary anti-inflation tool since 1991

Fiscal Policy

Cut spending or raise taxes to reduce aggregate demand

Addresses demand-pull inflation directly

Slower and politically harder than monetary policy

Key insight: Neither tool can fix cost-push inflation without creating unemployment — a painful trade-off known as stagflation, last seen in the 1970s oil shocks.

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Inflation is a tax on money — silent, universal, and felt most acutely by those who can afford it least. Low, stable inflation is not just a technical target; it is the foundation on which savings, investment, and long-run prosperity rest.

— Prof. Muhebullah Karimzada · ECON 101 · UNBC

Inflation · CPI · Demand-Pull · Cost-Push · Purchasing Power · Bank of Canada

In-flation