1. Inflation

2. Inflation Consistent increase in the general price level Types
Creeping
Slow to moderate
Hyper-inflation
Triple digit
Core inflation
Excludes volatile goods like oil and agriculture

3. Functions of Money Medium of exchange Store of value Unit of account
Allows deferral of payments over time
Unit of account
Goods and services can be put into common unit
***INFLATION DIMINISHES THESE FUNCTIONS

4. Deflation General price level decrease not to be confused with
Disinflation (fall in rate of inflation ex. 7% to 3%)

5. Costs of Inflation Redistribution Effects Losers (loss of real income)
Fixed incomes
Lenders
Savers
***Inflation erodes real interest rate
Lender loans money at 7%
Inflation = 6%
Real return= 1%

6. Winners Borrowers Wealthy Erodes real debt of original loan
Borrow at 7%
Inflation=6%
Real rate of borrowing=1%
Wealthy
Better information
Find inflation resistant assets
Land and fixed assets

7. Negative Effects on Growth
Causes increased interest rates
Lowers
Investment
Output
Increases
unemployment

9. Behavioral Distortions in the Economy
Can affect present and future consumption of firms and households

10. Shoe Leather and Menu Costs
Opportunity cost of shopping for the best prices (market analysis)
Loss of productivity
Menu Costs
Increased opportunity costs of updating prices and “menus”

11. Breakdown of Monetary System
Functions of money can wear down
Hyper-inflation
Currency becomes useless
Revert back to barter economy
High search costs to find co-wants and needs
Disruptions to govt. sector
Cash flow issues

12. Exchange Rates and Trade
High inflation
Causes domestic currency value to fall
Why?
Higher prices = less exports
Currency Derived Demand falls
Exchange rate falls
Increased exports
Decreased imports

13. 3.5.3 Costs of Deflation Benign Deflation SRAS shift right
Price decrease from A to C
Economy is growing
Real income increase

14. Malignant Deflation Decrease in AD leftward Output falls
Savings increases and Consumption falls
Investment falls
DEFLATIONARY SPIRAL
GREAT DEPRESSION

15. Solutions for Deflation
Hard to fix
Psychological element
Increase inflationary expectations of households and firms
Policies
Quickly lowering interest rates
Publicly announcing increase in target rate for inflation.
Issue consumption certificates (tax rebate for consumption)-

16. 3.5.4 Causes of Inflation 2 Main Causes are Keynesian in nature
Cost-push Inflation pg. 433
Supply shift left
Rising wages
Fall in exchange rate= increase price of imported raw materials
Increased labor taxes
Stagflation = decrease in output + inflation
Further S shift
Higher wages bid up (to offset higher Prices)
AD shift right
Caused by increased wages and fiscal policies (transfer payments)
Cost Push Spiral
Continuing cycle of cost-push

17. Demand Pull Inflation AD shift in short run SRAS shift left
Stimulatory fiscal/monetary policies
Consumer confidence
Result: higher prices
Bids up wages
SRAS shift left
Higher wages =higher costs
Cycle leads to Demand-pull spiral

18. Excess Monetary Growth
Could be a cause of Demand Pull Inflation
Increase Sm
Drops interest rates
Increases investment
Increases AD
Transmission Mechanism
Classical/Monetarists
Argue Money Supply is the best way to regulate the economy and inflation.