Prices in the Economy

This means that, on average, prices in the economy are 2.7 percent greater than they were a year ago. If you bought a jacket for $100 last year, you should expect the same jacket to cost about $102.70 right now. Not every single good and service increases by exactly this amount, of course. But, on average, prices are now 2.7 percent higher. A news report like this tells us that the things we buy have become more expensive. This matters to all of us. If your income has not increased over the last year, this inflation report tells you that you are worse off now than you were last year because you can no longer buy as much with your income. Most of the time, you will hear news reports about inflation only for the country in which you are living. Occasionally, you might also hear a news report about inflation somewhere else. In early 2008, you might well have heard a news report that the inflation rate in Zimbabwe was over 100,000 percent. You would probably find it difficult to imagine living in a country where prices increase so quickly, and you might reasonably wonder how two different countries in the world could have such different rates of inflation. When you have finished this book, you will know the answer to this question. Fiscal Policy in Action The bottom left screen in Figure 2.1 is something you may have seen before. It is a US tax form. Residents of the United States must file this form or one like it every year by April 15. If you live in another country, you almost certainly have to file a similar form. As individuals, we typically see this form as a personal inconvenience, and we don’t think much about what it means for the economy as a whole. But this is much more than a form. It is a manifestation of decisions made by the government about how much tax you and everyone else should pay. Decisions about how much to tax and how much to spend are known as fiscal policy. The fiscal policy adopted by a government affects your life in more ways than you can easily imagine. It not only tells you how much gets taken out of your paycheck, but it also affects real GDP and much more. It affects how likely you are to be unemployed in the future and how much money you will receive from the government if you do lose your job. It affects the interest rate you must pay on your car loan or student loan. It affects the tax rates you will pay 20 years from now and your likelihood of receiving social security payments when you retire. Monetary Policy in Action The bottom right screen in Figure 2.1 draws the attention of individuals and businesses all around the world. Every six weeks a group called the Federal Open Market Committee (FOMC) meets in Washington, DC, to make decisions on the course of US monetary policy. Their decisions affect the interest rates we pay on loans, including car loans, student loans, and mortgages. Their decisions also influence the level of economic activity and the inflation rate. The FOMC could, if it chose, create very high inflation by allowing rapid growth in the amount of money in the economy. It could, if it chose, create high rates of unemployment. It is a powerful organization. There are other similar organizations elsewhere in the world: every country conducts monetary policy in some form, and most have some equivalent of the FOMC.