Download Unemployment, Inflation, and Interest Rates

Unemployment,Inflation,and InterestRates
As real GDP (Y) (spending by consumers (C) + businesses (J)
+ the government ( G) + foreigners (X) (net exports: exportsimports) changes over time, so do other economic variables,
such as unemployment, inflation, and interest rates. These
economic variables give us a better understanding of the
human story behind the changes in real GDP and why real
GDP changes over time.
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Inflation
Just as real GDP and unemployment have fluctuated over time,
so has inflation. The inflation rate is the percentage increase
in the average price (P) level of all goods and services from
one year to the next. Often the expected rate of inflation
impacts consumer decisions. If prices are expected to go up,
some will buy earlier rather than later, and vice versa. The
inflation rate is included in nominal GDP. Inflation occurs
when nominal GDP grows quicker than real GDP; when price
levels increase.
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ina
B - l ions
versus
ofdo
Real
U.S.
GDP
crs
17 , (X)Q
o
·na
GDP
16 , 00C
15 , 000
Real
GDP
-
13 , 000
12 , 000
11 ...000
10 ...000
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-------,.---------,.--------,--------...---------,..-------------,.--------,---------,
2007
2005
2006
2008
2009
2010
2011
2012
Inflation(cont.)
Stagflation is persistent high inflation combined with high
unemployment and stagnant demand for goods in a country's
economy. Demand-pull inflation occurs when inflation is
caused by an excess of aggregate demand (AD) vs. supply,
(AS), like after natural disasters occur. Finally, a sticky price
is a price for goods or services that does not respond
immediately to changing economic conditions. Sticky price
situations can occur when busin ,ess leaders make production
decisions that do not create equilibrium in the market. It can
also occur because of the cost and time to communicate the
price change in society, like price tags or advertising. Because
of this, sticky prices have been used to explain the shape of the
short-run aggregate supply (SRAS)curve because the quantity
of goods supplied (Qs) does depend on the price level.
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Inflation(cont.)
Increases in aggregate demand (AD) causes the inflation rate to
increase and vice versa. This occurs because of the demand
which then leads to price increases over time. Higher inflation
rates make your money worthless. After WW I, Germany's
money was worthless because their inflation skyrocketed.
Prices for goods went up tremendously. The same happened to
the South during th American Civil War. A rapid increase in a
country's money supply creates hyperinflation, which explains
why governments just can't print more money. C,ost-push
inflation is inflation caused by an increase in prices of inputs
like labor, raw material, etc. The increased price of the factors
of production, like labor and materials, leads to a decreased
aggregate supply (AS) of the goods being made, and we know
that when supply (S) decreases prices (P) increase, which
causes inflation.
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Inflation(cont.)
A low and stable inflation rate has not been a feature of the
U.S. There are some useful facts to know about inflation.
First, inflation is closely correlated with the ups and downs in
real GDP (Y) and employment: inflation increased prior to
every recession of the last 40 years. Think of a bike going
down hill and picking up speed, just like an economy does as it
improves. Prices become inflated because firms know people
have more money and will pay more in the short-run (SR).
PER
E~"T
15.0
12.5
1 0.0
197S
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10
0
19
;-
10!)0
1995
.:,>ouo
Inflation(cont.)
Second, there are long-term trends with inflation. Disinflation
occurs when the inflation rate is slowing down. When
inflation is falling and average price (P) level falls, economists
call it deflation, something that sounds good but is very bad.
Third, there is no reason to expect the inflation rate to be zero.
The inflation rate has averaged around 2% or 3% since the
1990's, and that is the rate goal of most economies. The lower
and more stable inflation is in a country, the greater the chance
for economic growth, because high inflation puts more goods
and services out of reach for some who make less.
1.-
.0
1 2.5
1 9!)0
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2 000
The InterestRate and Inflation
The figure below represents the monetary policy rule
graphically. The nominal interest rate must rise by more than
the inflation rate if the real interest rate is to rise when inflation
•
rises.
11\'TEHE.ST HA g
( Pt-;llC I·:" )
J2
10
1
ominal
in t r " ~t r at
H al
in t r' t rat
l
4
6
~
'
I XFI.. .\ T I o , H \' r E
( PEHC£ ~'T)
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The InterestRate and Inflation(cont.)
Most central banks have a target inflation rate (about 2%)(the
inflation rate that the central bank tries to maintain on average
over the long run). Sometimes the inflation rate will rise and
sometimes fall below the target inflation rate. By reacting to
these movements in inflation, according to a monetary policy
rule, that is, by increasing the nominal interest rate when the
economy is expanding and inflation rises and cutting the
nominal interest rate when the economy is contracting and
inflation falls, the central bank can cause the actual inflation
rate (the real interest rate) to move back toward the target
inflation rate over time by adjusting the spending of consumer
consumption (C), business investment (J), and and net exports
(X) (exports-imports). Remember, government purchases ( G)
are not impacted by interest rates.
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Inflation-Questions
t.tl
.....:
->
°"
:.i:
c_., :i::
0..
SRAS,
AD
0
REAL
2
OUTPUT
32. Th e graph above sho,v aggregate den1and AD ) .
short-run aggregate supply (S RAS
and
curves for an economy. B ased
on tne graph, cost-push inflation is caused by a
moven1.ent from
(A) SRAS 1 to SRAS
(B) SRAS 2 to SRAS
(C) AD 1 to AD 2
( D ) AD 2 to AD1
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2
1
Inflation-Questions
t.tl
.....:
->
°"
:.i:
c_., :i::
0..
SRAS,
AD
0
REAL
2
OUTPUT
32. Th e graph above sho,v aggregate den1and AD ) .
short-run aggregate supply (S RAS
and
curves for an economy. B ased
on tne graph, cost-push inflation is caused by a
moven1.ent from
(.
SRAS 1 to SRAS
(B) SRAS 2 to SRAS
(C) AD 1 to AD 2
( D ) AD 2 to AD1
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2
1
Inflation-Questions
8.
~
lu h of the follo,ving ,vould gen rate o t-pu h
inflation?
A
B)
(C)
D)
E)
An in re< e in the pri of labor
A de r a e in the pri e of en rgy
An in rec e in hou ehold con 11nption
A deer a e in gov rn111entpending
An in rea e in the tnone)' upply
2. Inflation o cur ,vhen tJ1eie· a
in ,,1lii h of th follo,ving?
ll
Real gro dotne tic prod\1 t
The average pri e lev 1
Th price of any con11nodity
Labor produ tivity
The unen1ployn1entrate
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tained in rea e
Inflation-Questions
8.
~
lu h of the follo,ving ,vould gen rate o t-pu h
inflation?
• )
B)
(C)
D)
E)
An in re< e in the pri of labor
A de r a e in the pri e of en rgy
An in rec e in hou ehold con 11nption
A deer a e in gov rn111entpending
An in rea e in the tnone)' upply
2. Inflation o cur ,vhen tJ1eie· a
in ,,1lii h of th follo,ving?
ll
Real gro dotne tic prod\1 t
The average pri e lev 1
Th price of any con11nodity
Labor produ tivity
The unen1ployn1entrate
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tained in rea e
Inflation-Questions
51. Which of the following i a cau e of
hyperinflation?
(A
(B
(C
(D
(E
Rapid growth of real gro dome tic product
Rapid growth of the money upply
Unanticipated decrea e in aggregate demand
Unanticipated increa e in aggregate upply
Unanticipated ri e in real intere t rate
7. Hyperinflation i typically cau ed by
(A high tax rate that di courage work effort
B continuou expan ion of the money upply
to finance go emment budget deficit
C trade urplu es that are cau ed by trong
protectioni t policie
D· bad harve ts that lead to wide pread
hortage
E a large decline in corporate profi that
lead to a decrea e in production
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Inflation-Questions
51. Which of the following i a cau e of
hyperinflation?
(A
(•
(C
(D
(E
Rapid growth of real gro dome tic product
Rapid growth of the money upply
Unanticipated decrea e in aggregate demand
Unanticipated increa e in aggregate upply
Unanticipated ri e in real intere t rate
7. Hyperinflation i typically cau ed by
(A high tax rate that di courage work effort
continuou expan ion of the money upply
to finance go emment budget deficit
C trade urplu es that are cau ed by trong
protectioni t policie
D· bad harve ts that lead to wide pread
hortage
E a large decline in corporate profi that
lead to a decrea e in production
<
•
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