The Inflation Rate In The Eurozone, Its Calculation, Importance, And Causes

Topic B presents the information gathered from different web publications of how the inflation rate is calculated in the Eurozone as well as the Advantages and disadvantages of High Inflation, providing a better understand of the importance of inflation in the economy and how it is influenced. It also includes the effects of deflation in an economy, why it is a big concern of Central Banks, findings on measures taken by the European Central Bank to fight Deflation. At the end it Summarizes how uncertainty has already affect UK’s economy the possible impact of Brexit on UK inflation with or without a deal.

Question 1

Consumers price inflation is measured by the Harmonised Index of Consumer Prices (HICP) in Europe. It measures the change over time in the prices of consumer goods and services acquired, used or paid for by euro area households.

Since 1999 this indicator is used by the European Central Bank as a tool for measuring “price stability” within the euro area, and the EU aims to ensure that the HICP is around 2% per annum over the medium to long term. The European countries follow the same methodology so their data’s can be compared with one another.

High inflation is detrimental to a country's economy. When high or out of control, it can generate many problems and economic distortions.

Uncertainty can cause corporations to stop hiring and consumers to spend less. In addition, the economy must absorb repricing of goods and services, since wages are not rising at the same rate as prices. Firms need to cut payments, or fire people. Government collect less taxes but has more expenses since it is proved that unemployment increases governments expenses, because they need to pay more benefits, such as health care and other social services.

Exports tend to become more expensive and lose competitiveness and imports becomes cheaper and this may lead to the country importing more than it exports.

High Inflation also has it benefits; when inflation is high the country produces more money and although that causes the prices to rise, that also cause people to spend more money and that leads to aggregate demanding, hence creating more production to meet the demand. Therefore, companies that are not running at capacity will start to produce more so they will need more labor and that can create job opportunities.

It also helps debtors to pay back loans because it is easier for a debtor to repay his loan with money that is less worth now than when he loaned it. Also encourages borrowing and lending which also increases expending.

Question 2

Big financial crises have spiked concerns about deflation. These concerns increased in recent years after Japan's experience in the early 1990s. The Japanese economy was one of the fast-growing in the world when it started to experience deflation

Deflation is the fall in the prices of goods and services. When prices fall, people tend to postpone shopping, expecting prices to fall further. Thus, this waiting harm business, banking and global economic growth. There is not enough money flowing in the economy which means companies can’t sell their products, these companies will start to fire their employees because they are not making enough profit, hence economy is not using its full capacity.

This has been a problem in the real estate market as people do not buy houses for fear of the value falling after the purchase. In general, people are afraid of spending money in times of deflation because their assets can be worth less in the future.

The government can use methods of lowering interest rates on savings to force people to spend their money.

The ECB (European Central Bank) decided in a combination of measures to maintain target inflation. One of the measures that the ECB implemented was its own version of the Quantitative easing program (QE).

QE is a monetary policy normally used when other monetary policies were not effective. In periods that the inflation is way below what is expected or negative a central bank buys certain amounts of government bonds or other financial assets in order to inject liquidity directly into the economy.

Central Banks implements the QE by buying specific amounts of financial assets of Commercial Banks and Financial institutions therefore lowering their yield, while increasing the money supply.

In January 2015 the ECB announced that it would inject 1. 1 trillion euros into the eurozone economies through the purchase of government and corporate bonds at a monthly pace of 60 billion euros through to September 2016.

Negative Interest rate was imposed to stimulate the banks to lend money to business and individual to promote growth. A cut from 0 to -0. 1% was implemented in deposit rates for Banks and 0. 15% from 0. 25% in its Benchmark interest rate.

Another measure was to give cheap rates on long term loans to Commercial Banks so the more they invested in companies more cheaply they could borrow from ECB.

Question 3

In the UK, Inflation is measured by the Office for National Statistics (ONS). Although CPI is the most quoted figure, there is also the Consumer Prices Index including owner-occupiers' housing costs (CPIH) and the Retail Prices Index (RPI)

CPI measures the prices of the things consumers commonly spend their money on, giving preference to the things that can influence the interest rates.

After years of negotiation with the European Union the United Kingdom has not left the EU yet because they are trying to get a deal so they can have a “soft Brexit’’ meaning the UK would be aligned with the EU, with access to the single market and minimal impact on business.

Uncertainty about the Brexit final outcome has already damaged U. K. s economic growthy, some businesses has moved their headquarters to Europe. Before the referendum the British pound was around $1. 48 and fell to $1. 36 the next day. Although that might increases exports in another hand it decreases imports.

Brexit's impacts on UK inflation rates are based on speculations so it is difficult to define exactly what will happen, but the biggest assumptions point out that in a case of “no deal Brexit” the UK and the EU would not reach an agreement and there would not be a implementation period. Even with a deal Prices of goods and services would go up because of the increase in trade tariffs with the EU.

Most of the UK imports come from EU, but the higher import prices would create inflation and reduce the standard of living of UK residents.

Britain must then adjust its coin to stay competitive. In 2018 45% of goods and services of Britain were exported to countries in the European Union. When Brexit happens, they will lose their rights of free movements of goods which will make it more difficult to export their products.

That would affect British young workers. 3 million skilled workers will potentially lose their jobs in Europe. Companies would leave the UK and that would be creating even more unemployment therefore increasing the government costs.

I believe that the biggest impacts of Brexit will be in the case of no-deal; currency devaluation, an increase in unemployment, social services costs, high trades costs. In both scenarios the assumptions show that there will be an increase in inflation because of the adaptation period but there is a possibility of fast recovery in case of a good deal with the EU.