1. Opening
Assume that there is an increase in the demand for money at every interest rate. Graph the effect this will have on equilibrium interest rate for a given money supply. Now assume that the Fed is following a policy of targeting the Federal Funds Rate. What will the Fed do in the situation described to keep the rate unchanged. Illustrate on the graph.

2. Types of Inflation, Deflation and Disinflation
Module 33

3. Classical Model of Money and Prices
The classical view of changes in money supply is that they lead directly to changes in the price level
Nominal v. Real Money Supply:
Nominal = M
Real = M/P
Thus, the real money supply remains unchanged

4. Figure The Classical Model of the Price Level Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

5. Hyperinflation
Hyperinflation is most often caused by excessive money creation to cover government debt:
Too much debt means investors lose confidence in currency (dump it)
Central bank needs to create money to buy government bonds
Inflation increases rapidly (vicious cycle)
Seignorage: The ability of governments to pay for debt by creating money

6. Inflation Tax
Governments can pay debts by raising taxes However, if they pay debts by printing money, causing hyperinflation, they are in a sense “taxing” their citizens by the loss of purchasing power This is the “inflation tax”

7. Hyperinflation v. Gradual Inflation
At high rates of inflation, classical model holds But at gradual rates of inflation, prices are “sticky” and short-run changes matter Why? - Expectations

8. Gradual Inflation Cost-push inflation Demand-pull inflation
Price level increases due to cost of major input
Stagflation of the 1970s
Demand-pull inflation
Price level increases as a result of competition for goods, increasing wages
Too many dollars chasing too few goods

9. Output Gap and Unemployment
In earlier unit we examined the relationship between unemployment and output
In long-run macroeconomic equilibrium, the unemployment rate is equal to the natural rate
Recessionary gap: Unemployment is greater than the natural rate
Inflationary gap: Unemployment is less than the natural rate

10. Figure Cyclical Unemployment and the Output Gap Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers