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The Theory and Policy of Macroeconomics on Inflation Rate

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Macroeconomics also referred to as Keynesianism, is a branch in economics that deals with the structure, behaviour .performance and decision making of an economy as a whole microeconomics. Economists study the aggregate indicators in the economy such as the Gross Domestic Product (GDP), the price index, unemployment rates, inflation and other interrelations that exist among the different sectors of the economy (Dwivedi, 2010). In our discussion we are going to consider the historical sources of inflation rate in the study of macroeconomics.

In economics, inflation as defined as the sustained increment in the general price level of the services and goods produce in an economy over a particular period of time. This means that the value of money will decline i.e. the loss of purchasing power per unit of money. Inflation rate is used as the chief measure of inflation where the percentage change in the price index over a period time is calculated on yearly basis. Historical inflation rate records and Consumer price index has been used by different economies to represent inflation data. Economies are able to compare the growth rate of one period to another. In consumer price index, some of the factors used in the determination of inflation are:

  1. Fiscal imbalances. This kind of imbalances can either trigger faster growth of money or imbalance of payments hence forcing depreciation in the exchange rate thus leading to increase in inflation.
  2. Overheating economy. Inflation is caused by an activity variable such as an output gap in the economy.
  3. Cost shocks. This category is concerned with movement of prices of some sensitive goods in the economy. A good example is in the case of petrol, any alteration in price leads to aggregate change in the price level of all other commodities (Griliches, 2010).

Historical inflation rate majorly keeps records of the information obtained from the CPI to help in decision in future. Lastly, inflation forecast has been of importance in the economies where it has been applied in the following ways: Through inflation forecasting the government may know the appropriate time to offer inflation indexed bonds to its investors.

By analysing of market variables such as price, Inflation forecasting will help in improving of the quality of surveys and also enhance the understanding of the process of forecast formulation in an economy. Lastly, Reserve Banks monetary forecasting on households gives a measure of sentiment of inflation expectations in order to feed into the monetary policy process.

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