1. Session 7: Inflation 1. Go over Midterm 2. Review of Important Points from last time. –Chapter 11: Economic Growth –Chapter 15: Unemployment 3. Chapter 16: Price Stability –A. Definitions, Concepts, and some History –B. Economic Impact –C. The Phillips Curve –D. Some evidence of declining rate of NAIRU –E. Anti-Inflation Policies

2. A. Definitions, Concepts, and some History A1. What is inflation? A2. Three ways to classify: –A2a. Low, galloping, and hyperinflation –A2b. Anticipated and unanticipated –A2c. In AS/AD terms

3. English Price Level and Real Wage, 1264-2002 (1270 = 100)

4. Consumer Prices in the United States, 1776-2003

5. Inflation Has Remained Low and Stable in Recent Years

6. Money and Hyperinflation in Germany, 1922-1924

7. A2a. Classification by rate of inflation A2a(1) First in this category: Low –Problems: Minor, people can enter into long-term contracts –People trust money? Yes. –Need indices on Contracts? No. –Distorted Consumption patterns? No. –Typical Percentage rates? Single digit. –Examples: 1990’s in the US and Europe.

8. A2a. By rate of inflation (con’t) A2a (2) Second category: Galloping inflation –Problems: Becoming major, money losing value rapidly; people don’t lend money or enter into long term contracts –People trust money? Not much. –Need indices on Contracts? Almost. –Distorted Consumption patterns? Getting there. –Typical Percentage rates? Double or triple-digit. –Examples: 1970’s and 80’s in Argentina and Brazil.

9. A2a. By rate of inflation (con’t) A2a (3) Third category: Hyper inflation –Problems: Major, people can no way enter into long-term contracts; Demand for $  –People trust money? No. –Need indices on Contracts? Yes. –Distorted Consumption patterns? Yes. –Typical Percentage rates? > 100% per year. –Examples: Civil War in South;1920’s Germany.

10. Type People trust $ ? Need indices on contracts? Distorted Consumption Patterns? Percent per year Examples Low YesNo < 10Current US Gallop Maybe 50 to 700Latin Am. ’70’s; Argentina, Brazil Hyper No way. Yes  1000 US Civil War; Germany in early ’20’s

11. A2b. Anticipated and Unanticipated A2b (1): Anticipated –at modest rates –probably no effect. A2b (2): Un-anticipated –presents a problem.

12. A2c. In AS/AD terms Three types: –A2c (1). Inertial –A2c (2). Demand-Pull –A2c (3). Cost-Push

13. An Upward Spiral of Prices and Wages Occurs When Aggregate Supply and Demand Shift Up Together

14. Demand-Pull Inflation Occurs When Too Much Spending Chases Too Few Goods

15. B. Economic Impacts of Inflation Redistribution of income and wealth Economic Efficiency Effects –(1) Price signals distorted –(2) Use of money distorted –(3) Impact on taxes –(4) “Menu” costs –(5) Real value of Government programs –(6) High inflation makes policy makers act. –(7) Growth declines as inflation increases.

16. Interesting Aside: What is the optimal rate of inflation? With price stability – firms can predict prices, profits, and invest accordingly. Without/ output 1 to 3% lower; U 1 to 3% higher than with a 3% annual increase in prices. Why? –Firms can’t make downward wage adj. to balance S/D. –In fact, data from 1958-78 show that a < 0.1 percent of workers received wage cuts, even w/ years of low inflation.

17. Growth Rate Inflation Rate

18. The Short-Run Phillips Curve Depicts the Tradeoff between Inflation and Unemployment

19. The Shifting Phillips Curve

20. A Declining Rate of NAIRU?

21. Actual Unemployment Rate and NAIRU

22. Actual and Predicted Inflation, 1995-1999

25. Anti-Inflation Policies