Chapter 16: Inflation
The Inflation Tax
the reduction in the real value of money held by the public caused by inflation
Seignorage:
the revenue generated by a government's right to print money (less than 1% of US governments budget...although in the Civil War both sides printed money to finance the cost of war)
The increase in the price level is proportional to the increase in money supply
yes
Seignorage is equal to
∆M M= money supply ∆ = monthly change (its more useful to look at real seignorage, the revenue created by printing money divided by the price level, P)
Real Seignorage =
∆M ÷ P Real Seignorage = (∆M ÷ M) * (M/P) or Real seignorage = rate of growth of the money supply * real money supply
The Short-Run Phillips Curve:
(graph on slide)
if inflation is 5%, 1$ will buy you what a year from now
55cents
Okun's Law: If the natural rate of unemployment is 5.2% and the economy is producing at only 98% of potential output, the output gap is −2%, and Okun's law predicts an unemployment rate of?
= 5.2% − 0.5 × (−2%) = 6.2%.
a positive output gap implies an unemployment rate A. above the natural rate of unemployment. B. below the natural rate of unemployment.
B
Inflation Expectations and the Short-Run Phillips Curve
Changes in the expected rate of inflation affect the short-run trade-off between unemployment and inflation and shift the short-run Phillips curve.
Governments that run large deficits can: A. reduce the deficit by raising taxes. B. reduce the deficit by reducing spending. C. finance the deficit by printing money. D. Answers (a), (b), and (c) are all correct.
D
Inflation Tax equation
Equal to the inflation rate * the money supply
Cyclical Unemployment and the Output Gap
Finish
The Logic of Hyperinflation: To avoid paying the inflation tax, people reduce their real money holdings and force the government to increase inflation to capture the same amount of real inflation tax. In some cases, this leads to ___________________________________. This leads to hyperinflation and a fiscal crisis.
In some cases, this leads to a vicious circle of a shrinking real money supply and a rising rate of inflation.
Real Quantity of Money = ______ / ______
M= nominal money supply P= price level
Short-Run Phillips Curve: The short-run Phillips curve: the ________ short-run relationship between the _________ rate and the __________ rate
Negative Unemployment Inflation
What prevents a government from paying for its expenses by printing money?
Nothing. Just ask Robert Mugabe, Zimbabwe's leader (and cause of its hyperinflation).
According to the classical model of the price level, the real ______ of money is always at its _____-run equilibrium level.
Quantity Long
Since the SRPC shifts whenever inflationary expectations change, attempts to reduce unemployment below the natural rate may be effective only in raising prices.
Since the SRPC shifts whenever inflationary expectations change, attempts to reduce unemployment below the natural rate may be effective only in raising prices.
The Classical Model of the Price Level
The "classical" (pre-Keynes) model assumes the economy moves directly from E1 to E3—not necessarily a good assumption during normal times of low inflation.
The governments of wealthy, politically stable countries like the United States and Britain don't find themselves forced to print money to pay their bills. Yet over the past 40 years both countries, along with a number of other nations, have had uncomfortable episodes of inflation. Is there an asymmetry for politicians that favors inflation? If inflationary policies often produce political gains while policies to reduce inflation carry political costs, is it any wonder?
The governments of wealthy, politically stable countries like the United States and Britain don't find themselves forced to print money to pay their bills. Yet over the past 40 years both countries, along with a number of other nations, have had uncomfortable episodes of inflation. Is there an asymmetry for politicians that favors inflation? If inflationary policies often produce political gains while policies to reduce inflation carry political costs, is it any wonder?
If money supply increases, what will happen?
The increase in AD will increase the price level and output and eventually pull up nominal wages, which moves the SRAS curve leftward.
The long-run Phillips curve: the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience.
The long-run Phillips curve: the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience.
Okun's Law: Cyclical unemployment seems to move less than the output gap
The output gap reached −8% in 1982, but cyclical unemployment reached only 4%. Arthur Okun, John F. Kennedy's chief economic adviser, discovered this. Okun's law: there is a predictable negative relationship between the output gap and the unemployment rate. Modern estimates find that a rise in the output gap of 1% reduces the unemployment rate by about 0.5%.
In the short run, policies that produce a booming economy also tend to lead to higher inflation, and policies that reduce inflation tend to depress the economy. (to boom the economy aggregate demand should ________)
This creates both temptations and dilemmas for politicians. Increase
Defining and Measuring Inflation
a
Recall: When the output gap is positive (an inflationary gap), the unemployment rate is below the natural rate. When the output gap is negative (a recessionary gap), the unemployment rate is above the natural rate. Fluctuations in the long-run trend of potential output correspond to fluctuations in the natural rate of unemployment.
a
Zimbabwe's Inflation
a
An increase in money will ________ the economy, but ______ prices
boom increase
A policy that ______ the economy will _______ inflation. To lower __________ they have to ________ unemployment
booms, increase inflation, increase
THE AD-AS MODEL AND THE SHORT-RUN PHILLIPS CURVE
more graphs in the Slide Show
The real quantity of money
nominal money supply over the price level
