Inflation

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,

6th Edition, McGraw-Hill, 2000

Power Point presentation by Peter Smith

28.2

Inflation is ...

Inflation is a rise in the average price of goods over time

28.3

Some questions about inflation

Why is inflation bad?

What are the causes of inflation?

What can be done about it?

28.4

Inflation in the Taiwan, 1995-2004

-6

-4

-2

0

2

4

6

8

10

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

躉售物價

消費者物價

28.5

The quantity theory of money

The quantity theory of money says

that changes in the nominal money

supply lead to equivalent changes in

the price level (and money wages)

but do not have effects on output

and employment.

28.6

Money and prices

Milton Friedman famously claimed

‘Inflation is always and everywhere a

monetary phenomenon.’

28.7

Inflation and interest rates

FISHER HYPOTHESIS– a 1% increase in inflation will be accompanied

by a 1% increase in interest rates

REAL INTEREST RATE– Nominal interest rate – inflation rate– but the nominal interest rate is the opportunity

cost of holding money– so a change in nominal interest rates affects

real money demand

28.8

Hyperinflation … periods when inflation rates are very

large in such periods there tends to be a ‘flight

from money’– people hold as little money as possible

e.g. Germany in 1922-23, Hungary 1945-46, Brazil in the late 1980s.

Large government budget deficits help to explain such periods– persistent inflation must be accompanied by

continuing money growth

28.9

The costs of inflation

Fully anticipated inflation: Institutions adapt to known inflation:

– nominal interest rates– tax rates– transfer payments

no inflation illusion

Some costs remain:– shoe-leather

people economize on money holdings

– menu costs firms need to alter price lists etc.

28.10

The costs of inflation

Even if inflation is fully anticipated, the economy may not fully adapt– interest rates may not fully reflect

inflation

28.11

The costs of unanticipated inflation Unintended redistribution of income

– from lenders to borrowers

Uncertainty– firms find planning more difficult under

inflation, which may discourage investment

This has been seen as the most important cost of inflation

28.12

Defeating inflation

In the long run, inflation will be low if the rate of money growth is low.

The transition from high to low inflation may be painful if expectations are slow to adjust.

Policy credibility may speed the adjustment process

28.13

The Monetary Policy Committee

Central Bank Independence may improve

the credibility of anti-inflation policy

monetary policy has been set by the CB’s

Monetary Policy Committee– which has the responsibility of meeting the

inflation target via interest rates which are set

according to inflation forecasts.

28.14

Inflation and Unemployment

The Natural Rate of Unemployment – depends on various features of the labour

market, (e.g. minimum-wage laws, the market power of unions, the role of efficiency wages, and effectiveness of job search).

The Inflation Rate.– depends primarily on growth in the quantity of

money, controlled by the Central Bank.

28.15

Inflation and Unemployment

Macroeconomics focuses on three primary areas of our economy — output, prices, and unemployment. – If policy-makers expand aggregate demand,

they can lower unemployment, in the short-run, but only at the cost of higher inflation.

– If they contract aggregate demand, they can lower inflation, but at the cost of higher unemployment.

28.16

The Phillips curve

It suggests we can trade-off more inflation forless unemployment orvice versa.

A W Phillips demonstrated a statistical relationshipbetween annual inflation and unemployment in the UK

Unemployment rate (%)

Infla

tion

rate

(%

)

The Phillips curve showsthat a higher inflation rateis accompanied by a lower unemployment rate.

Phillips curve

28.17

The Phillips Curve

Illustrates the tradeoff between inflation and unemployment — a short-run relationship.

The Phillips Curve relates inflation and unemployment in the short-run as shifts occur in the aggregate demand and aggregate supply.

28.18

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1.00

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0.00 1.00 2.00 3.00 4.00 5.00 6.00

The Phillips curve, Taiwan 1995-2004

28.19

The Phillips Curve, the Aggregate Demand and the Aggregate Supply

The greater the aggregate demand for goods and services, the greater is the economy’s output and the higher the overall price level.

A higher level of output results in a lower level of unemployment.

Monetary and fiscal policy can shift the aggregate demand curve, thus moving the economy along the Phillips curve.

28.20

The Phillips curve and an increase in aggregate demand

Unemployment

Infla

tion

PC0U*

Suppose the economy begins at E, with zeroinflation, unemploymentat the natural rate U*...

U1

1

An increase in governmentspending funded by an expansion in money supplytakes the economy to A,with lower unemploymentbut inflation at 1.

A

28.21

痛苦指數

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2.00

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6.00

8.0019

95

1996

1997

1998

1999

2000

2001

2002

2003

2004

物價膨脹率

失業率

28.22

痛苦指數能衡量啥？ 所謂的痛苦指數或民生痛苦指數係根據一地區之失業率加上通貨膨脹率所計算，也就是以數量化指標，量化居民對當地生活品質不滿意的程度。

此一指數的計算乃因物價上漲削減了社會大眾的消費能力，而失業則是完全剝奪了個人的消費能力。因此，在現今的經濟學上，特別將通貨膨脹率及失業率兩者合稱「民生痛苦指數」。

一般痛苦指數的判定標準為，當指數超過 20%，即表示該國經濟處在悲慘狀態。

28.23

Inflation illusion

People have inflation illusion when they confuse nominal and real changes.

People’s welfare depends upon real variables, not nominal variables.

If all nominal variables (prices and incomes) increase at the same rate, real income does not change.