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Northwestern Project Classes 1,2 and 3 Life under high rates of inflation Inflation and Income inequality Inflation Targeting in Developing Economies Rubens Penha Cysne November, 2009 Key Concepts* Index number - An average that measures change over time of such variables as the price level and industrial 'production. Inflation - A rise in the average level of all prices. Inflation tax - The revenue the government raises by creating money (Steady State Definition). Economic Inequality – A measure of concentration of income or wealth among economic agents in an economy Inflation accounting - A method of reporting that allows for the financial effects of changes in the price level. *From Different Public Sources Inflation adjustment - Whenever any figure has an adjustment made for inflation or deflation. GDP Deflator. A price index indicating the prices of all currently produced goods and services. Interest - 1. the payment for current rather than future command over resources; the cost of obtaining credit. Or 2. the payment for the use of borrowed money. Or 3. the return paid to owners of capital. Interest rate - The rate charged on money borrowed or lent. Real Interest Rate: Interest Rate Adjusted for Inflation Nominal Values – Values that have not had the effects of inflation taken into account. Real Values – Values that have had the effects of inflation taken into account Nominal exchange rate - The rate (price) at which a person can trade the currency of one country for the currency of another. Real Exchange Rate – Nominal Exchange Rate Adjusted for Inflation Nominal GNP - The output off all goods and services valued at current prices. Real GNP – Nominal GNP adjusted for Inflation Welfare Costs of Inflation - The economic losses due to Inflation. Shoe leather costs of inflation. Time loss of money holders, for example by making trips to the bank. Menu costs of inflation. Time and effort lost due to price-list changes as a result of inflation Compounding - The process of adding interest each year to an initial capital sum. Compound interest - Apply interest on the capital plus all interest accrued to date. Indexation. The adjustment of nominal values for inflation, for example by means of cost-of-living adjustment clauses in labor contracts. Related Questions: Explain and exemplify the use of each one of the concepts above. Describe the way how real interest rates and real exchange rates are calculated. Provide some numerical examples in both cases. Why is it important to adjust nominal variables for inflation? Give some examples. Explain in words why inflation may cause losses to an economy. What would you have to say about deflation? Explain the concept of economic inequality. Downloadable Papers and Recommended Web Sites Paper 1 - Inflation and Inflation Tax in US and Mercosul (Only the Data) Paper 2 – Inflation and Income Inequality (Only the Conclusion) Paper 3 – Additional Definitions Related to Cosf of Living (Tom McGahagan) Recommended Web Site: American Economic Association: http://rfe.org/index.php Inflation in Brazil: Target and Realized Margem de Meta 14% Meta IPC FIPE 12% IPC FGV IPCA IBGE 10% 8% 6% 4% 2% 0% 1999 2000 2001 2002 2003 2003* 2004 Fonte: Banco Central do Brasil. * Metas reajustadas. 2004* 2005 2006 2007 2008 2009 Inflation and Exchange Rate (Dollar Price in R$) 14% Margem da Meta 4 Meta 3,5 IPCA IBGE 12% Câmbio (RS$/US$) Inflação 2,5 8% 2 6% 1,5 4% 1 2% 0,5 0% 0 1999 2000 2001 2002 2003 2003* 2004 Ano Fonte: Banco Central do Brasil. * Metas reajustadas. 2004* 2005 2006 2007 2008 2009 Preço do Dólar 3 10%