Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Inflation Inflation

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Overview ► The causes of inflation ► The effects of monetary injection ► The costs of inflation

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Inflation: Its Causes and Costs ► Inflation is a sustained increase in the price level. It is a continuous increase versus a “once-and-for-all” increase in prices. ► Inflation deals with the increase in the average of prices and not just significant increases in the price of a few goods.

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies The Causes of Inflation ► Inflation is an economy-wide monetary phenomenon that concerns, first and foremost, the value of an economy’s medium of exchange. ► To understand the cause of inflation as a monetary phenomenon we must understand the concepts of Money Supply, Money Demand, and Monetary Equilibrium.

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Monetary policy Definition Definition ► Economic strategy chosen by a government in deciding expansion or contraction in the country's money-supply. Applied usually through the central bank,

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Monetary Policy Monetary policy employs three major tools: 1. Buying or selling national debt. 2. Changing credit restrictions. 3. Changing the interest rates by changing reserve requirements. Monetary policy plays the dominant role in control of the aggregate- demand and, by extension, of inflation in an economy.

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies National Debt Total outstanding borrowings of a central government comprising of internal (owing to national creditors) and external (owing to foreign creditors) debt incurred in financing its expenditure.

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies National Debt National debt plays a crucial role in a country's financial system as government securities (being a secure vehicle for investment) form an important part of the reserves of its financial institutions

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies National Debt National debt is divided generally into three categories: 1. Floating debt, short term borrowings such as treasury bills, various ways-and-means advances, and borrowings from the central bank. 2. Funded debt, short-term debt converted into long-term debt. 3. Unfunded debt, national savings certificates, savings bonds, premium bonds, and securities repayable in foreign exchange (payment of which affects the country's balance of payments).

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Reserve Requirements Minimum amount of cash or cash- equivalents (computed as a percentage of deposits) that banks and other depository institutions, are required by law to keep on hand, and which may not be used for lending or investing.

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Reserve Requirements Reserve requirements serve as : 1. Safeguard against a sudden and inordinate demand for withdrawals (as in a run on a bank). 2. Control mechanism for injecting cash (liquidity) into, or withdrawing it from, an economy.

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Money Supply and Money Demand ► Money Supply is a variable of the Reserve Bank of a country. Through instruments such as open market operations, the RB directly controls the quantity of money supplied. ► Money Demand has several determinants including:  interest rates  average level of prices in the economy

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies ► People hold money because it is the medium of exchange. The amount of money people choose to hold depends on the prices of the goods and services. ► In the long-run, the overall level of prices adjusts to the level at which the demand for money equals the supply. Money Supply and Money Demand

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Hyperinflation & Inflation Tax ► Hyperinflation is inflation that exceeds 50 percent per month. ► Hyperinflation in some countries is caused because the government prints too much money to pay for their spending. ► Zimbabwe’s inflation rate went up to 3,731.9% !

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Hyperinflation & Inflation Tax ► When the government raises revenue by printing money, it is said to levy an inflation tax. An inflation tax is like a tax on everyone who holds money. ► The inflation ends when the government institutes fiscal reforms such as cuts in government spending.

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Types of inflation ► Demand –Pull Inflation ► Cost Push inflation

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Cost – push inflation Sustained increase in price of goods and services, caused by the passing off increased production costs to the consumers by the producers. Also called cost inflation, it is the opposite of demand-pull inflation.

Principles of Macroeconomics: Ch. 16 Second Canadian Edition Department : Business Studies Demand – Pull Inflation Sustained increase in the prices of goods and services resulting from a high demand, stimulated by easy credit and hire purchase offers accompanied by insufficient supplies. In general, more inflation is caused by demand-pull factors than by cost-push factors. Also called demand inflation, it is the opposite of cost-push inflation. In general, more inflation is caused by demand-pull factors than by cost-push factors. Also called demand inflation, it is the opposite of cost-push inflation.