Question

A newspaper article once reported that the U.S. economy was experiencing a low rate of inflation. It said that "low inflation has a downside: 45 million recipients of Social Security and other benefits will see their checks go up by just 2.8% next year."

a. Policymakers link increases in Social Security and other benefits to inflation because

they cannot link benefits to the stock market because of the Great Recession.

they are hoping to get more people in the U.S. interested in topics like inflation.

the Bureau of Labor Statistics lobbied to link benefits to inflation in the 1980s.

they wish to ensure that the real value of these benefits is constant over time.

b. Is the small increase in benefits a "downside" of low inflation, as the article suggested?

No, because Social Security recipients also obtain free Medicare coverage.

Yes, beneficiaries should obtain increases in benefits above inflation because prices of goods and services are always rising at a more rapid rate.

Yes, because Social Security recipients' benefits should be linked to GDP instead.

No, as long as inflation is measured correctly, Social Security beneficiaries' purchasing power will not change.

Answer 1

Ans a.

Inflation technically occurs when production lags behind money supply. As a result, prices rise for ensuring the efficient circular flow of income in the economy.

Inflation erodes the purchasing power of money. This means that a basket of goods that was affordable prior to inflation, would now become less affordable due to decline in purchasing power. So, an increase in benefits is often suggested to compensate for the rise in prices. As Social Security Benefits are meant for the retired and disabled population of the economy, ensuring their effectiveness is very crucial for policy makers for helping this segment receive the same level of benefits in times of inflation.

Hence,

Policymakers link increases in Social Security and other benefits to inflation because they wish to ensure that the real value of these benefits is constant over time (and not marred by inflation).

The right answer is Option 4.

Ans b

As inflation leads to increased prices of goods and services, benefits must increase more than the rise in prices for enabling people maintain the same level of consumption. That is, the benefits should increase by an amount that lets people buy the same quantities of goods and services that they were buying earlier.

Hence, the small increase in benefits is a "downside" of low inflation as beneficiaries should obtain increases in benefits above inflation because prices of goods and services are always rising at a more rapid rate.

The right answer is Option 2.