3.5.2-4 Inflation

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3.5.2-4 Inflation
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Inflation

• Consistent increase in the general price level
• Types
• Creeping
• Slow to moderate
• Hyper-inflation
• Triple digit
• Core inflation
• Excludes volatile goods like oil and agriculture

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Functions of Money

• Medium of exchange
• Store of value
• Allows deferral of payments over time
• Unit of account
• Goods and services can be put into common unit
• INFLATION DIMINISHES THESE FUNCTIONS

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Deflation

• General price level decrease
• not to be confused with
• Disinflation (fall in rate of inflation ex. 7
  to 3)

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Costs of Inflation

• Redistribution Effects
• Losers (loss of real income)
• Fixed incomes
• Lenders
• Savers
• Inflation erodes real interest rate
• Lender loans money at 7
• Inflation 6
• Real return 1

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• Winners
• Borrowers
• Erodes real debt of original loan
• Borrow at 7
• Inflation6
• Real rate of borrowing1
• Wealthy
• Better information
• Find inflation resistant assets
• Land and fixed assets

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Negative Effects on Growth

• Causes increased interest rates
• Lowers
• Investment
• Output
• Increases
• unemployment

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Behavioral Distortions in the Economy

• Can affect present and future consumption of
  firms and households

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Shoe Leather and Menu Costs

• Shoe Leather
• Opportunity cost of shopping for the best prices
  (market analysis)
• Loss of productivity
• Menu Costs
• Increased opportunity costs of updating prices
  and menus

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Breakdown of Monetary System

• Functions of money can wear down
• Hyper-inflation
• Currency becomes useless
• Revert back to barter economy
• High search costs to find co-wants and needs
• Disruptions to govt. sector
• Cash flow issues

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Exchange Rates and Trade

• High inflation
• Causes domestic currency value to fall
• Why?
• Higher prices less exports
• Currency Derived Demand falls
• Exchange rate falls
• Increased exports
• Decreased imports

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3.5.3 Costs of Deflation

• Benign Deflation
• SRAS shift right
• Price decrease from A to C
• Economy is growing
• Real income increase

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Malignant Deflation

• Decrease in AD leftward
• Output falls
• Savings increases and Consumption falls
• Investment falls
• DEFLATIONARY SPIRAL
• GREAT DEPRESSION

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Solutions for Deflation

• Hard to fix
• Psychological element
• Increase inflationary expectations of households
  and firms
• Policies
• Quickly lowering interest rates
• Publicly announcing increase in target rate for
  inflation.
• Issue consumption certificates (tax rebate for
  consumption)-

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3.5.4 Causes of Inflation

• 2 Main Causes are Keynesian in nature
• Cost-push Inflation pg. 433
• Supply shift left
• Rising wages
• Fall in exchange rate increase price of imported
  raw materials
• Increased labor taxes
• Stagflation decrease in output inflation
• Further S shift
• Higher wages bid up (to offset higher Prices)
• AD shift right
• Caused by increased wages and fiscal policies
  (transfer payments)
• Cost Push Spiral
• Continuing cycle of cost-push

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Demand Pull Inflation

• AD shift in short run
• Stimulatory fiscal/monetary policies
• Consumer confidence
• Result higher prices
• Bids up wages
• SRAS shift left
• Higher wages higher costs
• Cycle leads to Demand-pull spiral

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Excess Monetary Growth

• Could be a cause of Demand Pull Inflation
• Increase Sm
• Drops interest rates
• Increases investment
• Increases AD
• Transmission Mechanism
• Classical/Monetarists
• Argue Money Supply is the best way to regulate
  the economy and inflation.