<LOW/STABLE INFLATION>

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"This is a headline about 'disinflation'; prices have continued to rise but at a slower rate than the previous month last year. Mar-25 to Mar-26 was 3.3%, Apr-25 to Apr-26 was 2.8%."

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"That's right! When discussing inflation, most articles refer to changes in the prices of 'CONSUMER' goods and services."

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"...the CONSUMER PRICE INDEX (CPI) is a WEIGHTED PRICE INDEX that compares THE COST OF A REGULARLY REVISED BASKET OF CONSUMER GOODS & SERVICES that is deemed to represent a 'typical' household's requirements for maintaining a constant standard of living during a specific period to the cost of that same basket in a reference base period."

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"Q. What categories of goods & services are used?"

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"That's right! Clearly some price changes are more impactful than others on the average household; as such, these 'high-impact price changes' are given a higher 'weighting'."

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"Q. How are these 'weightings' worked out?"

"This weighting is based on the total expenditure on the item as % of total spending. In other words, once spending totals are known for every item in the basket, each is given a weight proportional to its share of total spending.

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"Below we can see the official 'broad category' weightings for the UK's CPI in 2022. As expected, the weightings add up to 100, with 'Housing & household services" given the highest weighting, and 'Health' the lowest'."

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"Q. What is a price index?"

"A PRICE INDEX compares the % changes in the price of these baskets from a base year price given a value of '100'."

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"If we click on the 'Table 1' tab below, you will see the UK CPI presented as a price index with 2015 as the base year given a value of 100."

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"What do you think the 141.8, in Apr 2026 means?"

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"Q. What can we say about the price of a basket that has an index value of '170'?"

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"That's right, the price of the basket has risen 70% in value since the base year."

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"Q. What can we say about the price of the basket that has an index value of '90'?"

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"That's right, the price of the basket has fallen 10% in value since the base year."

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"Let's construct a basic CPI step by step!"

"So if we use the formula..."

P. of Isak in 06/07 = P. of Isak in 2023 (£125m) * 100/700 = £17.9m

P. of Shevchenko in 2023 = P. of Shevchenko's in 06/07 (£30.8m) * 700/100 = £216m

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"Now use the formula to answer these questions, write a couple in your note book for reference."

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"In addition, there are three biases that seriously 'overstate' the impact it has on the average cost of living..."

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"We have already seen that due to numerous variables, consumer spending can differ from HOUSEHOLD to HOUSEHOLD and the basket's fixed content and weightings do not always accurately represent household expenditure. Given that baskets content and weighting differ from COUNTRY to COUNTRY, international comparisons are even more inaccurate."

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"When you see dramatic headlines like this, the media is almost always reporting the HEADLINE INFLATION RATE. This rate INCLUDES all goods and services in the basket, most notably VOLATILE ITEMS like FOOD (often affected by weather, crop diseases, etc) and ENERGY (often affected by geopolitical events, OPEC decisions, and seasonal demand), which as the headline states is the major contributing reason.

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"So what you might ask?"

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"The problem is that with these goods included this rate 'spikes' and 'crashes' regualrly from month to month (e.g., a war breaks out and oil prices double overnight), the headline rate can be very noisy. It gives you a picture of what is happening right now, but it is terrible at showing the underlying, persistent trend.

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"That's why it's best to use the CORE INFLATION RATE (or Underlying Inflation) which strips out these volatile food and energy prices. Central banks (like the Federal Reserve or the European Central Bank) almost exclusively focus on the Core CPI when making monetary policy decisions.

This essay will explain how the PPI can act as a useful predictor of future inflation."

STAGE 1: Define the key terms

A producer price index (PPI) measures the average change in the prices received by domestic producers of raw materials, intermediate goods, and capital equipment sold to other businesses. It is often seen as a leading indicator of consumer price changes. Inflation, by contrast, is a sustained increase in the general price level of goods and services in an economy over a period of time, typically measured by the CPI. This essay will explain how the PPI can act as a useful predictor of future inflation."

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STAGE 2: How PPI predicts Inflation

"The primary use of the PPI as a predictor lies in its ability to signal future cost-push inflation. Since the PPI measures the price of goods at the wholesale or production level, an increase in the PPI indicates that producers are facing higher costs for raw materials, energy, or intermediate goods. These higher production costs are a negative supply shock. To maintain their profit margins, producers will pass these increased costs onto consumers in the form of higher final prices. Therefore, a sustained rise in the PPI is a leading indicator that consumer prices (CPI) will likely rise in the near future."

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"A rising PPI can also predict demand-pull inflation. If the PPI is increasing because wholesale or intermediate markets are experiencing a surge in demand, this suggests strong economic activity. For instance, if businesses are bidding up the price of components and raw materials, it implies they are anticipating strong consumer demand for their final products. This increased aggregate demand, as it works its way through the supply chain, will eventually put upward pressure on the general price level, leading to demand-pull inflation."

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STAGE 3: Visualizing the Concept (The Diagrams)

"This process can be illustrated using the standard aggregate demand (AD) and aggregate supply (AS) model. For cost-push inflation, a rise in the PPI represents an increase in factor costs, causing the AS curve to shift leftward from AS₁ to AS₂. This results in a higher average price level (P₁ to P₂) and a lower level of real output (Y₁ to Y₂)."

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"Conversely, if a rising PPI signals strong demand in intermediate markets, it can inicate an increase in overall consumer spending. This would cause the AD curve to shift rightward from AD₁ to AD₂, leading to a higher price level (P₁ to P₂) and a higher level of real output (Y₁ to Y₂)."

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STAGE 4: Bringing it all together

Explain why it's a useful predictor, but also include a short note of caution to show evaluation.

"In practice, the PPI is considered a leading economic indicator. Governments and central banks, for instance, closely monitor the Producer Price Index for commodities like energy and food. A sharp increase in these PPIs often precedes a rise in headline CPI inflation, making it a key tool for forecasting and monetary policy decisions."

"However, it is important to note that the PPI is not a perfect predictor. The ability of producers to pass on costs depends on the state of the economy and the price elasticity of demand for their goods. In a recession, for example, a rising PPI might not immediately translate to higher CPI, as firms may be unable to raise prices for fear of losing customers. Despite this, its nature as a leading indicator makes the PPI an invaluable tool for predicting the direction of future inflation."

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💡TIP: "To decide if the stakeholder is a winner or loser, simply consider whether the 'purchasing power' of their subsequent income or debt has risen or fallen in value."

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--TASK--

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"Look at the stakeholders comments below and decide whether they are the winners and losers following unexpected inflation."

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The key point is: **modern governments and central banks generally do not “follow the Phillips curve” as though it gives them a menu from which they can permanently choose lower unemployment by accepting higher inflation.** Stagflation is one of the major reasons that interpretation was abandoned.

### 1. The original policy interpretation was too simplistic

The early Phillips-curve idea could be interpreted as:

**Lower unemployment ⇄ Higher inflation**

So policymakers might think:

> “We can stimulate AD, reduce unemployment from 6% to 4%, and accept a little more inflation.”

genui{"learning_viz":{"type_id":"PHILLIPS_CURVE","initial_values":{"demand_pressure":0}}}

That can still be useful **in the short run when the disturbance is primarily on the demand side**. If aggregate demand falls, for example, inflationary pressure and output/employment may both fall. Stimulating AD can therefore move the economy back toward potential output.

### 2. Stagflation doesn't actually destroy the modern Phillips curve

This is the crucial distinction.

Suppose oil prices suddenly rise substantially.

**SRAS shifts left → real GDP ↓ + price level/inflation ↑**

Therefore:

**Unemployment ↑ AND inflation ↑**

That's stagflation.

genui{"learning_viz":{"type_id":"SUPPLY_SHOCK","initial_values":{"supply_shift":-16}}}

But economists incorporated exactly this problem into the **expectations-augmented Phillips curve**. A modern version essentially says inflation depends on expected inflation, the degree of economic slack/demand pressure, **and supply shocks**. Federal Reserve research explicitly models inflation in this way. ([Federal Reserve][1])

So stagflation doesn't necessarily mean:

> “The Phillips curve is wrong.”

It means:

> **“The economy's short-run Phillips curve can shift.”**

genui{"learning_viz":{"type_id":"PHILLIPS_CURVE_SHIFTS","initial_values":{"shift_amount":1.2}}}

### 3. So why use the Phillips curve at all?

Because policymakers still need to understand **demand-driven inflationary pressure**.

Imagine unemployment is very low, vacancies are extremely high, firms are struggling to recruit, wages accelerate and aggregate demand exceeds productive capacity.

In that situation:

**AD ↑ → unemployment ↓ → inflationary pressure ↑**

The Phillips-curve mechanism is potentially useful.

Conversely, during a recession:

**AD ↓ → unemployment ↑ → inflationary pressure ↓**

Again, potentially useful.

Indeed, Federal Reserve policymakers have described Phillips-curve-type frameworks as **one tool** for understanding inflation, while recognising their limitations. ([Federal Reserve][2])

### 4. What governments should NOT conclude

This is the really important IB Economics distinction:

**Short run:** there *may* be a trade-off between unemployment and inflation.

**Long run:** there is **no permanent trade-off** that allows policymakers simply to choose permanently lower unemployment by accepting permanently higher inflation.

Suppose the government repeatedly stimulates AD to keep unemployment below its natural rate.

Initially:

**AD ↑ → unemployment ↓ → inflation ↑**

But workers eventually notice inflation and revise their inflation expectations upward.

They demand higher nominal wages → firms' costs rise → **SRPC shifts upward**.

Eventually unemployment returns toward its natural rate, except now inflation is higher.

The government would have to keep generating unexpectedly higher inflation to keep unemployment below that level—which is not a sustainable policy strategy. This natural-rate/expectations mechanism remains central to modern Phillips-curve modelling. ([Federal Reserve][1])

### 5. Therefore, your instinct is basically pointing toward the modern interpretation

I wouldn't teach students:

> **“Governments use the Phillips curve to choose between inflation and unemployment.”**

That's potentially misleading.

I'd teach:

> **“The Phillips curve helps policymakers understand one source of inflation—the relationship between economic activity, labour-market tightness and inflationary pressure—but the relationship can shift because of inflation expectations and supply-side shocks.”**

That makes stagflation much easier for students to understand.

In fact, recent Federal Reserve research explicitly discusses circumstances where **supply shocks create a conflict between stabilising inflation and stabilising economic activity**, rather than treating the Phillips curve as a fixed policy menu. ([Federal Reserve][3])

So for **IBDP**, I'd make the progression:

**Simple SR Phillips curve → apparent trade-off → stagflation challenges fixed relationship → Friedman/Phelps expectations → SRPC shifts → vertical LRPC → modern policymaking uses it as one imperfect model alongside AD-AS and other evidence.**

That is considerably more defensible than simply teaching “governments choose a point on the Phillips curve.”

[1]: https://www.federalreserve.gov/econres/feds/files/2024032pap.pdf?utm_source=chatgpt.com "Monetary Policy, Employment Shortfalls, and the Natural Rate Hypothesis"

[2]: https://www.federalreserve.gov/monetarypolicy/fomcminutes20180131.htm?utm_source=chatgpt.com "The Fed - Monetary Policy:"

[3]: https://www.federalreserve.gov/econres/feds/2025.htm?utm_source=chatgpt.com "The Fed - Finance and Economics Discussion Series (FEDS) - 2025"

https://time.com/6221771/stagflation-crisis-debt-nouriel-roubini/

• LEGO GREEDFLATION HERE