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MACRO Unit 4: Price Stability and Inflation Economics Some idea of inflation comes from seeing a youngster get his first job at a salary you dreamed of as the culmination of your career. - Bill Vaughan Created: 2012 by Jim Luke. This work is licensed under the Creative Commons Attribution-NonCommercial License MACRO Economics Society's Goals for Macro System Growth Stable Prices & Money Full Employment Stability of Business Cycle MACRO Economics Money: an elastic measuring stick License Some rights reserved by Truthout.org MACRO Economics Inflation is a sustained and generalized increase in most prices. Money loses real value Most observed (nominal) prices are rising MACRO Economics The Inflation Rate is the % change (annual rate) in most prices as measured by a price index. MACRO Economics Deflation is a generalized decrease in most prices. MACRO Economics Disinflation is a reduction in the rate of inflation. MACRO Economics Terms: - Nominal Prices: actually observed - Real Values: estimated value of goods using “base year” prices. MACRO Economics Inflation erodes financial wealth and fixed incomes. MACRO Economics But inflation also helps debtors and owners of real wealth. MACRO Economics Hyper-inflation Can Destroy. MACRO Economics Deflation Is Very Undesirable (any amount of deflation) MACRO Economics Practical Policy Goal: Low, stable inflation. MACRO Economics Measuring Price Stability “Price Index”: wtd average of sample of prices Several Price Indices CPI PPI GDP Deflator Index Number: base year = 100 Inflation Rate = % increase in the Price Index each year MACRO Economics Measuring Inflation Rate requires a price index. MACRO Economics A price index establishes price levels relative to an arbitrary “base year”. MACRO Economics Price Index: wtd average of prices based upon comparing the cost of “market basket” of goods each year. MACRO Economics Inflation Rate = percentage increase from year-to-year in price index MACRO Economics There are a lot of different price indices such as CPI, GDP Deflator, PPI, and Billion Prices Project. MACRO Economics Price indices are imprecise due to quality changes, new products, and shifts in preferences. MACRO Economics Inflation needs “momentum”, not just isolated increases. Attempts to measure it use “core inflation”. MACRO Economics What causes inflation? More demand in general than supply. MACRO Economics Nominal Interest Rates include a “real rate” component and an implied/assumed future inflation rate.