Transcript Document

Chapter 28
Inflation: Causes
and Consequences
Figure 28.1 Consumer Price Level
in the U.S., 1939-2002
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Causes of Short-Term Price Level
Fluctuations
• Nominal aggregate demand could rise
due to a nominal money supply
increase.
• Nominal aggregate demand could rise
due to a short-run increase in velocity.
• A fall in the growth rate of aggregate
supply could occur.
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Figure 28.2 Price Level Effects of an
Increase in the Money Supply
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Figure 28.3 Price Level Effects of an
Oil Price Increase
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Sustained Changes in the Price
Level: Inflation
• Sustained rates of change in the price
level constitute inflation.
• Inflation arises when aggregate demand
grows faster than aggregate supply.
• One-time shocks cannot by themselves
produce inflation.
• Sustained money supply growth causes
inflation but does not affect real output.
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Figure 28.4 Persistent Money
Supply Growth and Inflation
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Costs of Expected Inflation
• Inflation is a tax on real money balances if
they pay less than the market interest rate.
• If tax brackets are not indexed for inflation,
then the problem of bracket creep occurs.
• Expected inflation can also distort financial
decisions.
• Menu costs, or the costs of changing prices,
are another cost.
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Costs of Unexpected Inflation
• Because some contracts are set in nominal
terms, wealth redistribution can occur.
• Inflation uncertainty causes distortion of
information provided by prices.
• When inflation fluctuates significantly, relative
prices may change.
• An extreme case of uncertain inflation occurs
in a hyperinflation.
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Inflation and Monetary Policy
• Cost-push inflation results from workers’
pressure for higher wages.
• Demand-pull inflation results from
attempts to decrease the unemployment
rate too low.
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Figure 28.5 Demand-Pull Inflation
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Figure 28.6 Cost-Push Inflation
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Costs of Reducing Inflation
• Disinflation refers to a decline in
long-run inflation.
• The new classical view argues for an
immediate reduction in money growth.
• New Keynesians advocate slow and
steady reduction in money growth.
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Figure 28.7 New Classical
Suggestion: Cold Turkey Disinflation
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Figure 28.8 New Keynesian
Suggestion: Gradual Disinflation
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Central Bank Credibility
• A crucial factor in disinflationary policy is
central bank credibility.
• Appointing a “tough” central banker is
likely to increase central bank credibility.
• Some economists argue that the central
bank should adopt a rules strategy.
• Other economists support a discretion
strategy.
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Figure 28.9 Strategies for Changing
the Economy’s Equilibrium
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Figure 28.10 Payoffs from
Alternative Actions
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