TYPES OF INFLATION, DISINFLATION, AND DEFLATION MODULE 33
Transcript
1. TYPES OF INFLATION, DISINFLATION, AND DEFLATION MODULE
33
2. MONEY AND INFLATIONInflation may have complex causes.Very
high inflation is associated with rapid increases in the money
supply.To understand what causes inflation, we must understand the
effect of changes in the money supply on the overall price
level.
3. THE CLASSICAL MODEL OF MONEY AND PRICESRemember: in the long
run, an increase in the money supply does not change GDP.Other
things equal, an increase in the money supply leads to an equal
percentage rise in the overall price level (the prices of all goods
and services in the economy, including nominal wages and the prices
of intermediate goods, rise by the same percentage as the money
supply.
4. THE CLASSICAL MODEL OF MONEY AND PRICES
5. THE CLASSICAL MODEL OF THE PRICE LEVEL
6. THE CLASSICAL MODEL OF THE PRICE LEVELThe classical model of
the price level ignores the short run movements, and assumes that
the economy moves directly from one equilibrium at full-employment
to the next equilibrium at full-employment, as if the short-run as
well as the long-run aggregate supply curves were vertical.
7. THE CLASSICAL MODEL OF THE PRICE LEVELUnder periods of low
inflation, this model makes a poor assumption, as nominal wages and
prices are sticky in the short run.As a result, in periods of low
inflation, there is an upward sloping SRAS curves, and changes in
the money supply can change real GDP in the short-run.
8. THE CLASSICAL MODEL OF THE PRICE LEVELHowever, in periods of
high inflation the short- run stickiness of nominal wages and
prices tends to disappear.Workers and businesses are quick to raise
their wages and prices in response to changes in the money supply.
This makes for a more rapid return to long-run equilibrium under
high inflation.Therefore, the classical model of the price level is
more likely to be a good approximation of realities for economies
experiencing persistently high inflation.
9. HOW DOES THE GOVERNMENT RAISE REVENUE BY PRINTING MONEY?The
Treasury and the Federal Reserve work together to raise revenue by
printing money.1. The Treasury issues debt to finance the
governments purchases of goods and services.2. The Fed monetizes
the debt by creating money and buying the debt back from the public
through the open-market purchases of Treasury bills.
10. HOW DOES THE GOVERNMENT RAISE REVENUE BY PRINTING MONEY?The
Fed creates money out of thin air and uses it to buy valuable
government securities from the public sector.The US government does
have to pay interest on the debt owned by the Federal Reserve, but,
by law, the interest payments it receives on government debt go
right back to the Treasury, as it only can keep what it needs to
fund its own operations.
11. SEIGNORAGESeignorage refers to the amount of real
purchasing power that a government can extract from the public by
printing money.This means that the right to print money is itself a
source of revenue, as it refers to the revenue generated by a
governments right to print money.
12. SEIGNORAGEConcerns about seignorage dont affect the Feds
decisions about how much money to print, as the Fed is worried
about inflation and unemployment, not revenue.A government may find
itself with a large budget deficit and may not want or be able to
eliminate this deficit through contractionary measures or added
borrowing.
13. WHAT ARE THE EFFECTS OF PRINTING MONEY TO PAY FOR DEBT?In
these cases a government may end up printing money to cover the
budget deficit.However, when printing money to pay for its bills, a
government increases the quantity of money in circulation.These
increases in the money supply translate into equal increases in the
aggregate price level.So, printing money to cover a budget deficit
leads to inflation.
14. INFLATION TAXThe ones who end up paying for the goods and
services the government purchases with newly printed money are the
people who hold money.The inflation decreases their purchasing
power. Therefore, the government imposes a form of tax on the
people.This reduction in the value of the money held by the people,
by printing money to cover its budget deficit and creating
inflation, is referred to as an inflation tax.
15. INFLATION TAXIf the inflation rate is 3%, then in a year,
$1 will buy only about $0.97 worth of goods and services today.So
this 3% inflation rate imposes a tax of 3% on the value of the
money held by the public (because they lose 3% of their purchasing
power).
16. HOW DOES HYPERINFLATION OCCUR?Because inflation imposes a
tax on individuals who hold money, it leads people to change their
behavior.If inflation is high, people prefer to hold real goods or
interest bearing assets for money.They cut the amount of money they
hold so much that it actually has less purchasing power than the
amount of money they would hold if inflation were low, because, the
more real money holdings they have, the greater real amount of
resources the government captures from them through the inflation
tax.
17. HOW DOES HYPERINFLATION OCCUR?Countries can get into
situations of extreme inflation when they print a large quantity of
money, imposing a large inflation tax, to cover a large budget
deficit.
18. HOW DOES HYPERINFLATION OCCUR?
19. HOW DOES HYPERINFLATION OCCUR?
20. HOW DOES HYPERINFLATION OCCUR? This cycle progressively
leads to an even higher rate of inflation, which leads people to
hold even less money, and so on. Although the amount of real
seignorage does not change, the inflation rate the government needs
to impose to collect that amount rises. So, the government is
forced to increase the money supply more rapidly, leading to an
even higher rate of inflation, and so on. This self-reinforcing
process can easily spiral out of control, creating hyperinflation.
When this happens people are unwilling to hold any money at all, so
the government is forced to abandon its use of the inflation tax,
and stops printing money.
21. MODERATE INFLATIO AND DISINFLATION There are two possible
changes that can lead to an increase in the aggregate price
level:1. A decrease in aggregate supply, or2. An increase in
aggregate demand. Cost-push inflation is caused by a significant
increase in the price of an input that has economy-wide importance.
This increases the costs of production through the economy, which
drive prices up. Demand-pull inflation is inflation that is caused
by an increase in aggregate demand, which means that the aggregate
demand for goods and services is outpacing the aggregate supply and
driving up the prices of goods.
22. MODERATE INFLATION AND DISINFLATION In the short run,
policies that promote growth also tend to lead to inflation, and
policies that reduce inflation tend to depress the economy.
Politicians face a dilemma: inflationary policies often produce
short-term political gains, but policies to bring inflation down
carry short-term political costs. What to do? This political
asymmetry may explain why some countries that do not need to impose
an inflation tax sometimes end up with inflation problems.
23. THE OUTPUT GAP AND THE UNEMPLOYMENT RATE Potential output
typically grows steadily over time, reflecting long-run growth.
However, in the short run, actual output fluctuates around
potential output, creating recessionary or inflationary gaps.
Remember: The output gap is the percentage difference between the
actual level of GDP and potential output. This positive or negative
output gap occurs when an economy is producing more or less than
what is expected because the prices and wages.have not
adjusted.
24. THE OUTPUT GAP AND THE UNEMPLOYMENT RATE Remember: the
unemployment rate is composed of cyclical unemployment and natural
unemployment. The relationship between the unemployment gap and the
output gap is defined by two rules:1. When actual aggregate output
is equal to potential output, the actual unemployment rate is equal
to the natural rate of unemployment.2. When the output gap is
positive (inflationary gap), the unemployment rate is below the
natural rate. When the output gap is negative (recessionary gap),
the unemployment rate is above the natural rate .
25. THE OUTPUT GAP AND THE UNEMPLOYMENT RATE This means that
the fluctuations of aggregate output around the long-run trend of
potential output correspond to fluctuations of the unemployment
rate around the natural rate.:1. when output is lower than
potential, there is an unusually high unemployment rate.2. When
output is higher than potential, there is a lower-than-normal
unemployment rate.