1. Chapter 24 Money and Inflation

2. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-2 Money and Inflation: Evidence Inflation is always and everywhere a monetary phenomenon Whenever a country’s inflation rate is extremely high for a sustained period of time, its rate of money supply growth is also extremely high Reduced-form evidence

3. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-3

4. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-4 Views of Inflation Money Growth Fiscal Policy Supply Shocks Always a monetary phenomenon

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8. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-8 Origins of Inflationary Monetary Policy Cost-push inflation  Cannot occur without monetary authorities pursuing an accommodating policy Demand-pull inflation Budget deficits  Can be the source only if the deficit is persistent and is financed by creating money rather than by issuing bonds

9. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-9 Origins of Inflationary Monetary Policy (cont’d) Two underlying reasons  Adherence of policymakers to a high employment target  Presence of persistent government budget deficits

10. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-10

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16. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-16 Activist/Nonactivist Policy Debate Activists view self-correcting mechanism as slow Policy lags slow activist policy  Data lag  Recognition lag  Legislative lag  Implementation lag  Effectiveness lag

17. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-17 Activist/Nonactivist Policy Debate (cont’d) Nonactivists believe government should not get involved  Activist accommodating policy produces volatility in both the price level and output

18. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-18

19. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24-19 Expectations and the Activist/Nonactivist Debate If expectations about policy matter the accommodating, activist policy with high employment targets may lead to inflation Nonactivist policy may prevent inflation and discourage leftward shifts in short-run aggregate supply that lead to excessive unemployment  Must be credible Constant-money-growth-rate rule