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Macroeconomic Objectives
INFLATION
refers to a situation in the economy where there Is a general and sustained increased in prices, and is measured in
terms of indices such as the CPI.
Types and Causes
Policy Options
Demand-pull inflation (shifting AD)
Contractionary demand
Supply side policies

Increased AD (anything that changes CIGXM)
management policies.
Market policies
o Reduction in exchange rates
Generally used for Dd-pull
Manpower policies:
o Reduction in taxes
inflation.
- Improve efficiency of labour
o Reduction in i/r (hence Im)
markets such that unN
Fiscal policy
o Rising consumer confidence
- Better matching of workers to
o Faster economic growth externally
T  Im, C  AD
jobs

Changes in money supply
Pro-competition policies:
G  AD
o Money supply growing faster that output
Reduce the monopoly/market
o Increased bank borrowing
power of unions/business, such
Monetary policy
Cost-push inflation (shifting AS)
they unable to push up W rates
i/r   Im, C  AD

Higher costs
ahead of average productivity
SsM   i/r   etc
o Wage-push inflation
increases. (e.g. antitrust laws)
o Profits-push inflation - firms passing on costs to
Wage-Price policies
consumers by raising prices
- Wage guideposts
o Supply-side inflation - rise in prices of imported raw
- Price guideposts
materials
- Wage-price freeze
o Higher import/export prices
Supply side economics
o Increase in the level of indirect taxes
- Increase AS e.g., via increasing
o Structural inflation due to structural rigidities (like
technological capabilities
labour immobility)
Conflicts
Note that regulating inflation should always be a government’s first
priority as it may lead to a major economic collapse as well as the
implementation of currency reforms.
Meeting other policy objectives often conflicts with decreasing
inflation – e.g. increasing employment, economic growth etc.:
Phillips’ Curve: Trade off between unemployment and inflation?
Stagflation, slumpflation
Consequences
Internal
External
Case 1: Demand-pull inflation
Case 2: Cost-push inflation
BOP – CP, relative prices of exports   quantity of exports  
Negligible change in output,
output, unemployment and NY
current account worsens  feedback mechanism  problem
unemployment and NY all fall
worsens especially when inflation is cost-push, may alleviate
economy at Yf.
Consequently, SOL falls
demand-pull inflation*
GPL increases.
*Cheaper M  lower Dd for local goods  X-M  AE
Consequently, SOL falls.
FDI – FDI will probably  (due to inflation being a sign that the
economy is unstable), but depends on the degree of inflation
Short run
INFLATION
Long run
BOP worsens – pressure on xcr to depreciate.
Lower level of investments
Moderate/high inflation  business confidence   Im  rate of
EG limited (PPC does not shift out as much)
Mild inflation stimulates EG and builds business confidence as it is a
sign of a healthy economy  Im  PPC shifts outward
Savings decrease, consequently, EG is limited
The value of money falls as people would rather consume at the
present time  SsM available for Im  i/r  Im  EG is limited
Redistribution of income
Wage price spiral
Prices  Dd for higher W  W  prices  etc.
Function of money breaks down
- Money as a medium of exchange, serves as a store of value. Under
severe inflation, these functions break down. Regression of the
economy into one that deals with barter trade. Consequently, the
price mechanism is distorted (under hyperinflation) and can no
longer rationally allocate resources.