1. Copyright © 2004 South-Western Inflation-Related Topics Mod 33

2. Copyright © 2004 South-Western Inflation and Interest Rates Inflation and Interest Rates The Fisher effect refers to a one-to-one adjustment of the nominal interest rate to the inflation rate. According to the Fisher effect, when the rate of inflation rises, the nominal interest rate rises by the same amount. The real interest rate stays the same. Real Interest = Nominal Interest - Inflation

3. Copyright © 2004 South-Western Nominal Interest Rate and the Inflation Rate Copyright © 2004 South-Western Percent (per year) 196019651970197519801985199019952000 0 3 6 9 12 15 Inflation Nominal interest rate

4. Copyright © 2004 South-Western Types & Issues with Inflation Demand-pull Inflation Politically-motivated Inflation Cost-push Inflation Monetary Inflation Changes to the money supply (The Fed) Disinflation Deflation

5. Copyright © 2004 South-Western Demand-Pull Inflation More demand for goods than there are goods available Occurs because of Lack of goods available Econ expansion Political Motivations

6. Copyright © 2004 South-Western Cost-Push Inflation Higher input costs in production drive up prices Can occur because of: Increased costs overall of Land, Labor, Capital Increased costs due to Gov’t Regulations Supply shocks

7. Copyright © 2004 South-Western Monetary Inflation and the Quantity Equation This is Inflation due to amount of Money Supply Can be due to Fed Actions The Quantity Equation relates the quantity of money (M) and the velocity of transactions to the nominal value of output M x V ≡ Q x P M = quantity of money V = velocity P = the price level Q = the quantity of output

8. Copyright © 2004 South-Western Disinflation Disinflation refers to the actions to try to reduce inflation Disinflation is difficult AD/AS graph

9. Copyright © 2004 South-Western Deflation Definition Debt Deflation Effects of Expected Deflation Zero Bound Liquidity Trap

10. Copyright © 2004 South-Western Worksheet Practice Fisher effect Types of Inflation Monetary Equation