The Bank of Enlgand Coursework Example | Topics and Well Written Essays - 1500 words

The Bank of Enlgand - Coursework Example The governments and the central banks in all the economies of the world formulate their financial strategies to ensure that the inflation rates do not rise to high levels. However a comparatively more dangerous scenario arises when the inflation rates actually reach negative values, or deflation, because a case of deflation can damage the economy much more than a high inflation rate. Most central banks aim to control the inflation rates to low yet positive rates which are usually at 2-3%, and this is done by keeping the equilibrium point of aggregate demand and aggregate supply at the desired level, as shown in the figure on the right. The same has been the aim of the Bank of England, which is the central bank of England, to keep the inflation rates just above 2% during the financial period. This target has been in the strategy of the Bank of England since the past two years because a positive low inflation rate which is stable and under control is considered the best for the economy . The factors of exactly why deflation is a worse scenario than inflation will be discussed later on in the assignment. Inflation rate is determined by three measures which are Consumer Price Index (CPI), Retail Price Index (RPI) and RPIX. CPI is a measure of the change in the price of consumer goods and services. RPI is calculated by measuring the change in price of all the retail goods and service in the economy. Last is the RPIX which is used in the United Kingdom and is calculated by subtracting mortgage interest payments from RPI. Types of Inflation Inflation is when the general prices of the goods and services in an economy are increasing. Due to the rise in the prices, it has a negative effect on the purchasing power of the money in the economy. Such is because the people can buy a lesser quantity of goods and services with the same amount of money compared to the last year. There are two types of inflation which are anticipated and unanticipated inflation, and both of them c reate a different impact on the economy. (tutor2u, n.d.) The first type of inflation is anticipated inflation is when the inflation rate can be correctly calculated and the people can protect themselves from its effects. An example of anticipated inflation and protect oneself from it is when the labor union collectively bargains for a wage rise in order to keep the real wages at the same level. They are able to bargain because they are aware of the inflation rate and keep in accordance with it. The second type of inflation is unanticipated inflation. The truth is that the inflation rates can never be predicted to an exact level and the actual interest rate may usually vary to the calculated inflation rate. This variance is called the unanticipated inflation rate, and it exists because the inflation rates are very volatile from year to year and therefore it becomes difficult to correctly predict the rate. Since it is unknown, the people cannot protect themselves from it (Gillespie, 2 007, pp. 382-383). An example of this is when a natural disaster such as an earthquake or flood, there is a sudden increase in demand for tents. This situation is showed in the figure above. Inflation is caused by cost push and demand pull factors. Cost push inflation is when the rise in prices occurs due to the rise in prices of the raw materials. When the prices of the raw materials increase, the aggregate supply in the economy decreases and the curve shifts to the