Download Inflation: Its Causes and Cures Inflation • Introduction

Survey
yes no Was this document useful for you?
   Thank you for your participation!

* Your assessment is very important for improving the work of artificial intelligence, which forms the content of this project

Document related concepts

Deflation wikipedia, lookup

Real bills doctrine wikipedia, lookup

Fear of floating wikipedia, lookup

Edmund Phelps wikipedia, lookup

Recession wikipedia, lookup

Nominal rigidity wikipedia, lookup

Interest rate wikipedia, lookup

Full employment wikipedia, lookup

Money supply wikipedia, lookup

Business cycle wikipedia, lookup

Monetary policy wikipedia, lookup

Inflation wikipedia, lookup

Phillips curve wikipedia, lookup

Stagflation wikipedia, lookup

Inflation targeting wikipedia, lookup

Transcript
Inflation
• Introduction
– Examine
Inflation:
Its Causes and Cures
• the fundamental causes of inflation
• the responsiveness of inflation to shifts in AD & AS
– Inflation requires
• a continuous increase in AD, or
• a continuous contraction in AS
1
2
Figure 8-1 Relationship of the Short-Run Aggregate Supply Curve (SAS) to the Short-Run
Phillips Curve (SP)
Inflation
• Real GDP, the Inflation Rate, and the
Short-Run Phillips Curve
– Introduction
• A continuous increase in AD pulls the price level up
continuously
– Demand pull inflation
» Figure 8-1
» Key assumption: nominal wages do not adjust
instantaneously
3
4
Inflation
Inflation
• Real GDP, the Inflation Rate, and the
Short-Run Phillips Curve (continued)
• Real GDP, the Inflation Rate, and the
Short-Run Phillips Curve (continued)
– Effects of an Increase in Aggregate Demand
– How Continuous Inflation Occurs
» Figure 8-1
• A One-Shot Increase in Aggregate Demand
» Figure 8-1 (top)
• A Continuous Increase in Aggregate Demand
» Figure 8-1 (bottom)
5
6
1
Inflation
Inflation
• Real GDP, the Inflation Rate, and the
Short-Run Phillips Curve (SP) (continued)
• The Adjustment of Expectations
– Changing Inflation Expectations Shift the SP
Curve
– The SP Curve
» Figure 8-2
» Figure 8-1 (bottom)
• Once the SP shifts upward with higher p(e), Y
cannot exceed Y(n) unless p accelerated
• Long-run equilibrium exists only when there is no
pressure for change
• For Y > Y(n) the economy is not in long-term
equilibrium because p > nominal wages
• Nominal wages keep rising because workers have
failed to correctly anticipate future inflation
– p(e) = 0
• Position of SP curve depends on expected p
– Expectations-augmented Phillips curve
7
Figure 8-2 Effect on the Short-run Phillips Curve of an Increase in the Expected Inflation
Rate (pe) from Zero to 3 Percent
8
Inflation
• The Adjustment of Expectations (con’t)
– The LP “Correct Expectations” Line
• The LP line shows all possible points where p(e) = p
– Long-run Phillips line
– “correct expectations” line
• To the right of the LP line,
p > p(e), p(e) will rise
• To the left of the LP line,
p < p(e), p(e) will fall
• Y cannot be permanently raised beyond Y(n)
9
10
Inflation
Inflation
• Nominal GDP Growth and Inflation
• Effects of an Acceleration in Nominal GDP
Growth
Nominal GDP (X) =
Price Level (P) times Real GDP (Y)
or
X=P*Y
» Figure 8-3
– Begin at (long-term) equilibrium
• on the SP curve
• x = p or y = 0
• p(e) = p
In growth rate terms
x=p+y
11
12
2
Figure 8-3 The Adjustment Path of Inflation and Real GDP to an Acceleration of Nominal
GDP Growth from Zero to 6 Percent When Expectations Fails to Adjust
Inflation
• Effects of an Acceleration in Nominal GDP
Growth (continued)
– Adjustment process
• Nominal GDP grows
– real GDP grows because x > p
– create disequilibrium because off the SP curve
• Inflation accelerates
– move back to the SP curve
– y < x and p > 0
– Short-term equilibrium established
13
14
Inflation
Inflation
• Effects of an Acceleration in Nominal GDP
Growth (continued)
• Expectations and the Inflation Cycle
– The Continuing Adjustment
– Forward-Looking, Backward-Looking, and
Adaptive Expectations
• How far Y can be increased depends on how fast
p(e) responds to higher p
• Because not in long-term equilibrium
– x > p and p(e) < p
• Because x > p, y > 0
• Forward-Looking Expectations
– economy must continue to grow until x = p
– Based on forecasts of economic variables
• Because p(e) < p
– p(e) must rise, shifting SP curve up
• Process continues until long-term equilibrium is reestablished
15
16
Inflation
Inflation
• Expectations and the Inflation Cycle (con’t)
• The Adjustment of Expectations
(continued)
– Forward-Looking, Backward-Looking, and
Adaptive Expectations (continued)
– Adjustment Loops
• Backward-Looking Expectations
• How the economy actually responds to higher
demand growth will depend on the speed of the
adjustment of expectations
– Based on the past behavior of economic variables
– Rationality of:
» Forecasts are difficult and often incorrect
» The adjustment process is often gradual
– Adaptive expectations
» Expectations are adjusted to the difference between
what was expected to happen and what actually
happened
» Figure 8-4
• Characteristics of the inflation process
– An acceleration in demand raise p and Y in the short-run
– If p(e) adjusts to p then x = p and rise in Y is temporary
– During adjustment p > x
17
18
3
Figure 8-4 Effect on Inflation and Real GDP of an Acceleration of Demand Growth from
Zero to 6 Percent
Inflation
• Recession as a Cure for Inflation
– How to Achieve Disinflation
– The “Cold Turkey” Remedy for Inflation
» Figure 8-5
• Sudden reduction in demand growth
– Divided between inflation and real output
– Leads to a recession
19
Figure 8-5 Initial Effect on Inflation and Real GDP of a Slowdown in Nominal GDP Growth
from 10 Percent to 4 Percent
20
Inflation
• Recession as a Cure for Inflation (con’t)
– The Adjustment Process to the New Long-Run
Equilibrium
• Introduction
– Long-run equilibrium exists when
» p=x
» p(e) = p
» “Missouri” effect and the adjustment process
» Figure 8-6
21
Figure 8-6 Adjustment Path of Inflation and Real GDP to a Policy that Cuts Nominal GDP
Growth from 10 Percent in 1980 to 4 Percent in 1981 and Thereafter
22
Inflation
• Recession as a Cure for Inflation (con’t)
– The Adjustment Process to the New Long-Run
Equilibrium (continued)
• The Downward Spiraling Loop
– Mirror image of Figure 8-4
– Economy overshoots long-rum equilibrium
• A Fatter Loop
– Shape of the loop and length of the adjustment process
depend on the shape of the SP curve
» Flatter SP curve implies flatter, deeper, and slower
adjustment process
23
24
4
Inflation
Inflation
• Recession as a Cure for Inflation (con’t)
• CASE STUDY: Why Inflation Declined in
the 1980s and 1990s
– The Output Cost of Disinflation
• The Sacrifice Ratio
– 1981-82: A Classic Disinflation
– The cumulative output lost to achieve a permanent
reduction in inflation
– Cumulative output lost / inflation improvement
• Introduction of tight monetary policy
• Sharp deceleration in nominal GDP growth
» Figure 8-7
25
Figure 8-7
The Inflation Rate and the Output Ratio, 1980–1996
26
Inflation
• CASE STUDY: Why Inflation Declined in
the 1980s and 1990s (continued)
– Disinflation and the Revival of Inflation During
the 1982-90 Expansion
• Introduction of fiscal expansion
• Re-acceleration in nominal GDP growth
• Oil prices fell sharply in 1986
27
28
Figure 8-8 The Inflation Rate, The Actual Unemployment Rate, and the Natural Rate of
Unemployment, 1980–97
Inflation
• CASE STUDY: Why Inflation Declined in
the 1980s and 1990s (continued)
– Comparing the Actual and Natural Rates of
Unemployment
» Figure 8-8
– Steady Inflation During 1994-1996
• Natural rate of unemployment declined
– Declining Inflation During 1997-1998
29
30
5
Inflation
Inflation
• CASE STUDY: Why Inflation Declined in
the 1980s and 1990s (continued)
• The Importance of Supply Disturbance
– Introduction
• Demand inflation
• Supply inflation
– Why Did the Natural Rate of Unemployment
Decline in the mid-1990s?
» Figure 8-9
• Falling price of computers
• Disinflation for medical care services
• Weaker bargaining position for labor
• Global competition
31
Figure 8-9 Four-Quarter Growth Rates of the GDP Deflator and Nominal GDP and the
Level of Nominal and Real Oil Prices, 1970–96
32
Inflation
• The Importance of Supply Disturbance
(continued)
– Types of Supply Shocks
• Supply inflation stems from sharp changes in
business costs that are not related to prior changes in
nominal GDP growth
• Temporary versus permanent
33
34
Inflation
Inflation
• The Importance of Supply Disturbance
(continued)
• The Response of Inflation and Real GDP to
a Supply Shock
– Types of Supply Shocks (continued)
– Effects of Supply Shocks on the Price level and
on the Rate of Inflation
• Adverse shocks shift the SP curve backward
– Rising raw material prices
– Regulation and/or less competitive pressures
• Temporary Supply Shocks
– Do inflationary expectations change?
• Beneficial shocks shift the SP curve outward
– Falling raw material prices
– Deregulation and/or increased competitive pressures
– Rapid technological innovation and implementation
• Permanent Supply Shock
– Do inflationary expectations change?
• Supply shocks and policy decisions
35
36
6
Figure 8-10 The Effect on the Inflation Rate and the Output Ratio of an Adverse Supply
Shock that Shifts the SP Curve Upward by 3 Percent
Inflation
• The Response of Inflation and Real GDP to
a Supply Shock (continued)
– Supply Shocks and the Short-Run Phillips
Curve (SP)
• Supply Shocks Shift the SP Schedule
» Figure 8-10
37
38
Inflation
Inflation
• The Response of Inflation and Real GDP to
a Supply Shock (continued)
• The Response of Inflation and Real GDP to
a Supply Shock (continued)
– Policy Responses to Adverse Supply Shocks
– What Happens in Subsequent Periods
• Economy’s response depends on the response of
nominal GDP growth which in turn depends on
government policy actions
• Introduction
– SP curve shifts up in the initial period
– What happens next depends on p(e)
» No change in p(e)
» A rise in p(e)
† Viewed as permanent or temporary
† The effect of cost-of-living adjustments (COLAs)
– Neutral Policy Response
» Maintain nominal GDP growth
– Accommodating Policy Response
» Maintain output ratio
– Extinguishing Policy Response
» Maintain inflation rate
• The Policy Dilemma
39
40
Inflation
Inflation
• The Response of Inflation and Real GDP to
a Supply Shock (continued)
• Inflation and Output Fluctuations:
Recapitulation of Causes and Cure
– Effects of Favorable Supply Shocks
– A Summary of Inflation and Output Responses
» Figure 8-11
• Shift the SP curve outward
• The policy options
• Case A: Demand Shifts Alone
• Case B: Supply Shifts Alone
• Case C: Demand and Supply Shifts in the Same
Vertical Direction
• Case D: Demand and Supply Shifts in Opposite
Directions
41
42
7
Figure 8-11 Responses of the Inflation Rate (p) and the Output Ratio (Y/YN) to Shifts in
Nominal GDP Growth and in SP
Inflation
• Inflation and Output Fluctuations:
Recapitulation of Causes and Cure
– Cures for Inflation
• Policies to slow nominal GDP growth
• Policies to create beneficial supply shocks
• Luck
43
44
8