Download Inflacja - E-SGH

The Inflation Problem
Persistent long-term inflation – a post-World War II
problem in most industrial countries. 60 years ago the idea
that prices would continue to rise for the next 60 years
would have been considered extreme. But prices did rise
year after year from 1955 on, and now most people expect
them to continue rising
1
Main questions asked
 Why inflation is so difficult to control?
 Why despite annouced plans of governments has
inflation stayed with us?
 Why should we care about inflation?
 What harm or good does it do?
 Can we get rid of inflation?
 Should we change the structure of economy so that
inflation becomes easier too live with?
2
The quantity theory of money
 The link between transactions and money expressed in the quantity equation:
 M x V = P x Y,
 M- quantity of money, V-velocity, frequency with which the dollar or euro is
used in the economy, usually V does not change often; P – price level; Y-real
GDP
 „V” and „Y” – real variables
 „P” and „M” – nominal variables, expressed in dollars or euro
 Implications of the quantity theory of money
 1) If M ↑ and no change in V , P or Y must ↑
 Y (real GDP) fixed at the natural rate of output,then
 The only variable which may change is the price level (P), P↑ = inflation
 Printing money (M) means inflation
 2) nominal variables can not affect real variables, monetary policy can not
change the level of output and employment
3
Inflation and money growth
 „Inflation is always and everywhere a monetary
phenomenon” (Milton Friedman Nobel Prize 1976)
 According the quantity theory of money the growth in M is the
primary determinant of the inflation rate
 Friedman claim is empirical not theoretical. „A Monetary History of
the US 1867-1960” with A. Schwartz: the positive correlation
between money growth and inflation is evidence for the QTM
(decade data)
 A monthly data on money growth and inflation rate do not show a
close correlation between those two variables
 The theory works best in the long run not in the short run
4
Inflation and interest rates









Two interest rates: nominal and real
The real interest rate is the difference between the nominal rate and the rate of inflation
The I.Fisher (1867-1947) equation:
The nominal interest rate = real interest rate + the rate of inflation
According quantity theory of money the change in nominal money supply causes identical
change in price (and wage level): 1% increase in M causes 1% increase in price level (no changes
in output and employment)
According Fisher equation real interest rate and the inflation rate determine the nominal
interest rate: a 1% increase in the rate of inflation causes 1% increase in nominal interest rate
(Fisher effect)
Those two equations together tell us how growth of money supply affects the nominal interest
rate
The link between inflation and interest rates is well known to stock exchange investors: bond
prices move inversely with interest rates, one can get rich predicting correctly the direction in
which interest rate will move
Wall Street firms hire Fed Watchers to monitor monetary policy and news about inflation to
anticipate changes in interest rates

5
Bond prices and interest rates
 A bond – a promise to pay a specific amount of interest each year and






the repay the principal when the bond matures
If the interest rate 8% and you want to borrow $100
You have to pay 8% for some period (20 years) and then repay $100
You may borrow $100 by selling the lender a bond, promissing to pay
the specific interest
The lender can sell your bond for market price = $100, if interest rate is
8%
When interest rate goes up to 10%, existing bond promissing to pay 8%
is worth less than $100 (present value of it is $83)
So the bond prices move inversely with the interest rates
6))
Demand -pull inflation and costpush inflation
 Demand-pull inflation –prices pull-up by the increase of




demand
the shift of AD curve to the right because of: fiscal stimulus
(higher government spending, lower taxes), monetary
stimulus (lower interest rate),faster economic growth
outside the economy
Effects: rising prices, higher real GDP and employment
Cost-push inflation – shift of short-run supply curve to the
left because of : the increase of components costs, rising
labor costs, higher indirect taxes
Effects: higher prices and lower GDP, may lead to
stagflation
7
Deflation
 When rate of inflation becomes negative – general
price level falling and value of money increasing
 It does not happen very often
 Recent years: the case of Japan due to severe recession,
China due to large investment and high productivity
 May be observed on individual markets as audio-visual
equipment (new technologies, innovation)
 May be dangerous for the economy: why shall I buy
today?
8
Budget deficit and inflation
 Statistical data do not show the direct connection between
budget deficit and inflation
 The link between those variables depends on that how the
budget deficit is financed:
 Governmnet may sell bonds (money borrowed from the
private sector), increased quantity of money used to finance
deficit
 Government may print the money, attractive when budget
deficit very large
9
Inflation and unemployment
 Phillips curve (1958): shows an inversive realtionship between the inflation rate
and unemployment. The higher the rate of inflation, the lower the rate of
unemployment
•
•
The Phillips curve represents the trade-off between inflation and unemployment.
Policymakers can reduce unemployment by expanding AD ( move from E
(equilibrium) to A. The tightness of the labor and good markets will make for higher
wages and cost increases and thus for higher inflation. The history of inflation in
the 1960s seemed to confirm the Phillps curve trade-offs.
Central Bank raises the interest rate to reach inflation target. The economy slowly
moves to E. The impact of interest rate change after 1-2 years.
10
Troubles with the Phillips curve after 1970








1970s: unemployment rate and the inflation rate>10% (UK). Effects of the supply shock: oil prices
tripled, rising the price level, 1973-74). Short run Phillips curve shifted up, equilibrium point E much
higher on LRPC than in 1960.
Two possible reactions of government: a) increase of M (easy monetary policy) to avoid the decrease
in M/P and in AD. Unemployment does not grow, but the rate of inflation goes up; b) no change in M
(restrictive monetary policy). Higher inflation means lower M/P, higher interest rate and the recession.
Case b) called stagflation – a period of continuing inflation combined with a recession or stagnation
of economic activity (1969-71 US).
Why tight monetary policy not effective? 1)Inflation expectations built in to wages contracts. Tight
monetary policy affects output and employment but has no effects on inflation (prices are not going
down). 2) expectations on future of economic policy very important, the role of government
credibility. Once workers convinced the government really will fight inflation, more easy monetary
and fiscal policy would be possible
That was the case of US disinflation in 1980s (P. Volcker period) or UK in 1980s ( M. Thatcher
period)
How does a policy become credible? A question for political scientists, not for economists only
a political cycles: each new government makes a tough-sounding predictions on inflation
Most of them gave up on their counter-inflationary policies – not long run approach, policies
adjusted to election timetable
11
The Phillips curve long run (1)
 (M.Friedman 1968 r.)
•
•
•
•
People interested in real not nominal wages, they adjust nominal wages to inflation rate
E – long run equilibrium lays on the short run Phillips curve. Trade-off between inflation and
unemployment only during the short period of adjustment to AD change.
Once workers expectations on inflation have time to adjust, the natural rate of unemployment
(NRU) is compatible with any rate of inflation, does not depend on inflation rate
Short run Phillips curve will shift with a persistent change in the average rate of inflation. The
more quickly workers expectations adapt to inflation, the more quickly unemployment will
return to NRU.
12
The Phillips curve long run (2)
 Long run equilibrium constant rate of inflation
 No errors made in inflation expectations
 Nominal wages adjusted to inflation expectations to keep real wages at




long run equilibrium level
Nominal interest rate high enough to compensate inflation and keep
real interest rates at equilibrium level
All agents are able to adjust to inflation because they know the future
inflation rate
Let us assume the inflation rate=10%. Monetary policy target: 10% rate
of growth of nominal money supply or 10% inflation rate
Long run equilibrium at E (10% inflation and 10% nominal money
supply rate of growth
The costs of inflation

Shoe – leather costs – inflation wears out the shoe leather of consumers by making
them walk to the bank more often

Menu costs – costs of changing tag printing new catalogs, costs of parking meters
adjustmnet, pay telephones or slot machines. Introduction of tokens may diminish the
costs.

Redistribution of income from creditors to debtors because prices change faster than
nominal interest

Redistribution between the old and the young: the old built up savings in savings bank
or in the form of pension, increase in the price level will make the poorer in real terms.
The youn are debtors, they gain from inflation

Inflation redistributes income away from the poor toward the rich, but a little evidence
on that

Bracket creep when share of taxes in a given amount of real income increases with the
increase in prices.

Rising uncertainty about future price levels and inflation rates
14
Hyperinflation
 Extraordinary periods in which instability of prices so extreme that it
disorganizes the production, markets and redistributes income and wealth in
society
 Inflation rates exceed 1000% per year
 Often associates with war or social revolution. Case of Bolivia 1985 11.000%,
Poland 1989 almost 700%, Germany 1920s
 Germany: money exploded, for every reichsmark that he held in Jan. 1922, the
average person held 20 million in late 1923.
 Inflation rate has increased from 80% per year (5% per month) in 1922 to
30.000% per month or 20% per day in 1923
 Not only money worthless but also all assets fixed in nominal terms
(governments bonds, pensions, insurance policies) – middle class ruined by
inflation, and inflation has raised the support for „law and order” government
 Beneficiares of the hyperinflation: the debtors
15
What can be done about inflation?
 1. new policies to help monetary and fiscal policy fight inflation: a)incomes
policies influencing wages and other incomes directly rather then through AD
b) wage and price control. Both failed: income policy treated as a substitute to
macroeconomic policy rather than complement; price control difficult to
administer
 2. change the way those policies are used , so that inflation rate once lowered
will stay low. Preventing rapid money growth usually mentioned here: targets
for money growth announced.
 3. we can learn to live with inflation, institutions should be fully adjusted for
inflation: indexation automatically adjusts payments for the effects of
inflation, but is difficult to implement, lags between the time price change and
the time payments can be adjusted. Imperfect indexation and still present
shoe-leather costs keep inflation costs high.
 None of 3 methods presents any quick and easy solution to the inflation
problem
16
Changes in inflation rate in Poland
year
Inflation rate %
1982
70.3
1986
17.0
1988
73.9
1989
639.3
1990
249.3
1993
37.2
1998
13.2
2002
3.6
2004
1.7
2006
2008
1.4
3.5
17
Inflation rates in Poland
Stopa inflacji w %
700
639,3
600
500
400
300
249,3
200
100
70,3
73,9
37,2
17,0
13,2
3,6
1,7
1998
2002
2004
0
1982
1986
1988
1989
1990
1993
Rok
18
Balcerowicz shock therapy
 Rising the interest rate above the inflation level
 Reduction of subsidies and tax exemptions, tax system
reform
 Substantial decrease in real wages (elimination of price
control of consumption goods)
 Tight fiscal and monetary policy allowed to decrease the
inflation rate
 Ending the state control over income levels
 Recommendations to privatize the state owned industries
 The Balcerowicz plan passed to the law December 1989
19