Money and Inflation Rise in money supply does not equal a rise in Real GDP in the long run since price level rises as well by the same percentage Classical Model of Price Level Since money supply and price level rise together the Real Quantity of Money MP stays at the original level ID: 1027659
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1. Inflation and Unemployment
2. Money and InflationRise in money supply does not equal a rise in Real GDP in the long run, since price level rises as well by the same percentageClassical Model of Price Level – Since money supply and price level rise together, the Real Quantity of Money (M/P) stays at the original levelWages and prices are more responsive to money supply changes in periods of high inflation
3. The Inflation TaxPrinting money to cover debt drives up inflationInflation tax is the reduction in value of money held by public when the government prints money to cover deficitsThe U.S. can and does raise revenue by printing money – This is what happens when the Fed buys bonds to increase money supply
4. HyperinflationDuring times of inflation, people hold as little money as possiblePrinting money (seignorage) creates revenue:(∆M/M) ● (M/P) OR Rate of growth of MS ● Real MSWhen govt needs to collect a certain amount but people are holding less money, must increase rate of growth… which can spiral out of control
5. Moderate Inflation and DisinflationTwo shifts can lead to an increase in aggregate price level, emphasizing the importance of:Cost-push inflationDemand-pull inflation – which can result from expansionary policiesEconomic policies have political ramifications, which explains why inflation can get out of control
6. Output Gap & UnemploymentOutput gap is the difference between current level of output and potential outputBecause the unemployment rate is the natural rate + cyclical unemployment, there is a relationship between output gap and unemployment rateWhen aggregate output = YP, unemployment = natural rateWhen output gap is positive, unemployment < natural rateWhen output gap is negative, unemployment > natural rate
7. The Short Run Phillips CurveThe SRPC depicts the negative short run relationship between the unemployment rate and inflation rate
8. Inflation Expectations and SRPCExpected inflation rate is the 2nd most important factor affecting inflationActual rate of inflation at any given unemployment rate is higher when expected inflation rate is higher
9. Long Run Phillips CurvePersistent attempts to keep unemployment low result in accelerating inflation To avoid this, unemployment must be high enough that actual rate of inflation = expected rate, resulting in nonaccelerating inflation rate of unemploymentNAIRU means there is no longterm tradeoff between unemployment and inflation
10. Long Run Phillips CurveLRPC is vertical because it is at NAIRU (natural rate)Economists estimate NAIRU by looking at relationship between inflation rate and unemployment over the course of the business cycle
11. Costs of DisinflationTo bring down inflation, contractionary policies raise unemployment above the natural rate for an extended periodAs a result, the economy loses potential output
12. DeflationValue of money rising over timeDebt deflation results from borrowers cutting back their spending because of the additional burden of repaying money that is worth more, reducing aggregate demand – which leads to more deflation, which can spiral out of control
13. Effects of Expected InflationFisher Effect shows that interest rates are impacted by expected inflation one-to-oneIn case of deflation, interest rates will fall – but they are zero bound – which creates a limit for monetary policyInterest rate too low leaves no incentive to save and a credit freezeLiquidity trap results from sharp reduction in demand for loanable funds, causing interest rates to fall so low that monetary policy is ineffective