INFLATION
A sustained rise in the average level of prices.
Since more money is required to make purchases when
prices rise, inflation is sometimes defined as a decrease
in the purchasing value of money. Economists measure
price changes with various price indexes. The most
widely used index in the United States is the consumer
price index (CPI).
Inflation may result if the demand for goods
increases without an increase in the production of
goods. Inflation may also take place if the cost of pro-
ducing goods increases. Producers pass on increased
costs, such as higher wages and more expensive raw
materials, by charging consumers higher prices.
INTEREST RATE
The cost of borrowing money.
Interest is calculated as a yearly percentage, or rate,
of the money borrowed. A 10 percent interest rate,
therefore, would require a borrower to pay $10 per
year for every $100 borrowed.
When interest rates are low, people will borrow
more, because the cost of borrowing is lower.
However, they will save and invest less, because the
return on their savings or investment is lower. With
high interest rates, people save and invest more but
borrow less. Because interest rates affect the economy,
governments take steps to control them. The United
States government does this through the Federal
Reserve System, the nation’s central banking system.
The graph below shows the relationship between the
rate ofinflationand interest rates in the American
economy over time.
KEYNESIAN ECONOMICS
The use of government spending to encourage econom-
ic activity by increasing the demand for goods.
This economic approach is based on the ideas of
British economist John Maynard Keynes (shown
below). In a 1936 study, Keynes pointed out that dur-
ing economic downturns, more people are unemployed
and have less income to spend. As a result, businesses
cut production and lay off more workers.
Keynes’s answer to this prob-
lem was for government to
increase spending and reduce
taxes. This would stimulate
demand for goods and services
by replacing the decline in con-
sumer demand. Government
would want goods and services
for its new programs. More
people would be working and
earning an income and, there-
fore, would want to buy more goods and services.
Businesses would increase production to meet this new
demand. As a result, the economy would soon recover.
Critics maintain, however, that Keynesian econom-
ics has led to the growth of government and to high
taxes, inflation, high unemployment, and greatly
reduced economic growth.MINIMUM WAGE
The minimum amount of money that employers may
legally pay their employees for a set period of time
worked.
Legislation sets the minimum wage at a fixed hourly,
weekly, or monthly rate. In some countries, the mini-
mum wage applies to all workers. In others, it applies
only to workers in particular industries. Also, some
countries set a different minimum wage for men,
women, and young workers. The first country to pass
minimum wage laws was New Zealand in 1894. Since
that time, most industrialized countries have adopted
such legislation. The graph on the next page shows
estimates of minimum monthly wage rates in selected
countries.
The first federal minimum wage law in the United
States, the Fair Labor Standards Act of 1938, set the
base wage at 25 cents an hour. Since then, amend-
ments to the act have raised this hourly rate to $5.15,
effective in 1997. The Fair Labor Standards Act
applies to workers in most businesses involved in
interstate commerce.Inflation and Interest Rates, 1980–2000
1980 1984 1988 1992 1996 200016
1412
108
6
42
0PercentInflation Rate
Prime Interest RateSource: Bureau of Labor Statistics; Federal Reserve SystemECONOMICSHANDBOOKR69