代写Macro1 (Econ1010)Inflation: Its causes and costs
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代写Macro1 (Econ1010)Inflation: Its causes and costs•Macro1 (Econ1010)
Lecture 8
(Chapter 30)
•Inflation: Its causes and costs
•Insert lecturer’s name and contact here
•
•Inflation:
A Refresher and the Big Picture
•A video related to this week’s topic introducing the concept of price stability here:
http://www.ecb.int/ecb/educational/pricestab/html/index.en.html
•What is inflation and how do we measure/calculate it?
•Two main questions today:
1)What is the main cause of inflation?
2)How does inflation affect the wellbeing individuals
•To put the debate into perspective, let’s look at inflation performance in the past...
•History of inflation
•What has been the average inflation rate over the past 60 years in Australia?
•And over the past 10 years?
•What was the inflation rate in the 1970s?
•Did we ever observe deflation? Why?
•And disinflation?
•And hyperinflation?
•
•Inflation over the VERY long run (1600-2000) Source: Sargent (2010)
•Inflation
•Inflation is an increase in the overall level of prices.
•Deflation is a decrease in the overall price level.
•Hyperinflation is an extraordinarily high rate of inflation.
•The Causes of Inflation
•If P is the price of goods and services, measured in terms of money, then 1/P is the value of money measured in terms of goods and services.
•When the overall price level rises, the value of money falls.
•The demand and supply of money determines the value of money.
•Causes of inflation
•What is the ‘easiest’ way to create high inflation?
•Milton Friedman ‘Inflation is always and everywhere a monetary phenomenon.’
–What does he mean?
•The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate.
•Money supply
•The money supply is a policy variable that is controlled by the central bank.
•Through instruments such as open-market operations, the central bank directly controls the quantity of money supplied by the banking system.
•Note that the RBA no longer targets the money supply. The RBA now targets interest rates and inflation.
•Money demand
•Money demand has several determinants, including interest rates and the average level of prices in the economy.
•People hold money because it is the medium of exchange.
•The amount of money people choose to hold depends on the prices of goods and services.
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•The classical dichotomy and monetary neutrality
•Nominal variables are variables measured in monetary units.
•Real variables are variables measured in constant units.
•This separation is the classical dichotomy.
•According to the classical dichotomy, different forces influence real and nominal variables.
•
•The classical dichotomy and monetary neutrality
•Real economic variables do not change with changes in the money supply.
•Changes in the money supply affect nominal variables but not real variables.
•The irrelevance of monetary changes for real variables is called monetary neutrality.
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•Quantity theory of money
•The velocity of money refers to the speed at which the typical dollar bill travels around the economy from wallet to wallet.
•Velocity (V) = nominal GDP (P × Y) / money supply (M)
•The quantity equation:
M ´ V = P ´ Y
–What is the right hand side?
•Velocity and the quantity equation
•The quantity equation shows that an increase in the quantity of money in an economy must be reflected in one of the three other variables:
–the price level must rise
–the quantity of output must rise, or
–the velocity of money must fall.
•Velocity and the quantity equation
•Explaining the equilibrium price level, inflation rate and the quantity theory of money:
–Assume the velocity of money is relatively stable over time.
–When the central bank changes the quantity of money, it causes proportionate changes in the nominal value of output (P ´ Y).
–Because money is neutral, money does not affect output.
•Velocity and the quantity equation
–When the central bank alters the money supply, these changes are reflected in prices.
–Therefore, when the central bank increases the money supply rapidly, the result is a high rate of inflation.
代写Macro1 (Econ1010)Inflation: Its causes and costs
•Nominal GDP, Money, and the Velocity of Money
•Money Neutrality
•The figure shows that velocity of money is relatively stable over time
–What can affect it?
•What does real output depend on?
•Therefore, using M ´ V = P ´ Y, what effect will an increase in the quantity of money ultimately have?
•The irrelevance of monetary changes for real variables is called money neutrality.
•One crucial qualification (which we will discuss in future lectures) – the distinction between the short and long run
•Let’s look at this in a diagram
•The equilibrium price level
•The effects of a monetary injection
•Maintaining Price Stability
•Case study: money and prices during hyperinflations
•Hyperinflation is inflation that exceeds 50 percent per month.
•What is the only way to create high inflation?
•An example:
•Hyperinflations in History
•The inflation tax
•Why does the government print too much money?
•inflation tax
–An inflation tax is like a tax on everyone who holds money.
•How can you end a hyperinflation?
•The Fisher effect
•the Fisher effect: How does the nominal and real interest rate respond to the inflation rate?
•Nominal interest rate = real interest rate + inflation rate
•According to the Fisher effect, when the rate of inflation rises, the nominal interest rate rises by the same amount.
•The real interest rate stays the same.
•Let’s see if it is really true...
•The nominal interest rate and the inflation rate
•The costs of inflation
•Has anyone here experienced high inflation? How did it affect your life?
–Ask your parents about the 1970s/80s.
•One homeowner talking to his neighbour: "You know, inflation’s not so bad. At least it allows us to live in a higher-priced neighbourhood without having to move.“
–What’s wrong with the logic?
•Inflation does not in itself reduce people’s real purchasing power.
•What are you going to do if you expect higher inflation?
–Wages
–Interest rates…
•Costs of
High Inflation and Deflation
•Anticipated inflation:
–Frequency of firms’ changing prices?
•Menu costs
–Tax distortions
•indexation?
•Unanticipated inflation:
–Investment: creditor vs. debtor
–Fairness
•Deflation:
–Postponing consumption and investment
–Possible ‘liquidity trap’
•Inflation-induced tax distortion
•Inflation exaggerates the size of capital gains and increases the tax burden on this type of income.
代写Macro1 (Econ1010)Inflation: Its causes and costsredistributes wealth among the population in a way that has nothing to do with either merit or need.
•These redistributions occur because many loans in the economy are specified in terms of the unit of account – money.
–If inflation turns out higher than expected: who loses and who gains?
•Implications for Monetary Policy
•Having identified the costs of inflation, an important question arises:
•Why do central banks commonly have inflation targets of around 2% rather than 0% (which would be perfect price stability)?
•There are two main reasons:
–Keeping well away from deflation
–Being able to reduce interest rates by more in a downturn
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•US Monetary Base (Currency + bank’s reserves at the Fed) in the global crisis
•Summary
•The overall level of prices in an economy adjusts to bring money supply and money demand into balance.
•When the central bank increases the supply of money, it causes the price level to rise.
•Persistent growth in the quantity of money supplied leads to continuing inflation.
•Summary
•The principle of money neutrality asserts that changes in the quantity of money influence nominal variables but not real variables.
•A government can pay for some of its spending simply by printing more money.
•This can result in an 'inflation tax' and hyperinflation.
•Summary
•According to the Fisher effect, when the inflation rate rises, the nominal interest rate rises by the same amount, and the real interest rate stays the same.
•Many people think that inflation makes them poorer because it raises the cost of what they buy.
•This view is a fallacy, however, because inflation also raises nominal incomes.
•Summary
•Economists have identified six costs of inflation:
–shoeleather costs
–menu costs
–increased variability of relative prices
–unintended tax liability changes
代写Macro1 (Econ1010)Inflation: Its causes and costs
