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Unit 5
Inflation, Exchange Rates and
Modern Macro
Chapter 32
Inflation, Disinflation and Deflation
I. Inflation
a) Rising Prices
b) Inflation Tax: A reduction in the value of
money held by the public caused by inflation.
II. Hyperinflation
a) Extreme, rapidly rising prices (100,000%)
b) How does this occur?
1) Gov. prints large amounts of money to cover a
budget deficit.
2) Public reduces money holdings
3) Gov. must print more and more to make ends
meet.
II. Moderate Inflation and Disinflation
a) Cost-Push Inflation: caused by increase in
prices of inputs important to economy
1) Decreases AS curve
2) Ex. OIL
b) Demand-Pull Inflation: increase in aggregate
demand.
1) “too much money chasing too few goods”
Practice
1) Use a correctly labeled aggregate supply and
demand graph to illustrate cost-push
inflation. Give an example of what might
cause cost-push inflation in the economy
besides oil prices.
III. The Phillips Curve
a) Shows the tradeoff between inflation and
unemployment.
Discussion: What happens to inflation and
unemployment when AD increases?
IV. The Long Run Phillips Curve
a) Relationship between unemployment and
inflation after expectations of inflation have
adjusted.
1) Disinflation: the process of bringing down
inflation.
2) Very costly, usually creates high levels of
unemployment.
V. Liquidity Trap
a) Interest rate is zero bound: cannot go below
zero
b) Liquidity trap: Monetary policy cannot be
used anymore because interest rates are zero
bound.
2011 FRQ
• Handout