Sunteți pe pagina 1din 26

Chapter 30

Inflation and
Disinflation

Copyright © 2008 Pearson Addison-Wesley. All rights reserved.


In this chapter you will learn to

1. Describe the response of wages to change in both output gaps


and inflation expectations.
2. Explain how a constant rate of inflation is incorporated into the
basic macroeconomic model.
3. Describe the effects of aggregate demand and supply shocks on
inflation and real GDP.
4. Explain what happens when the Federal Reserve validates
demand and supply shocks.

5. Describe the three phases of a disinflation.


6. Explain how the cost of disinflation is measured by the sacrifice
ratio.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-2
Figure 30.1 U.S. CPI Inflation,
1965–2006

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-3


Adding Inflation to the Model

Why Wages Change


1. Output Gaps
- Y > Y*  excess demand for labor (U<U*)
- Y < Y*  excess supply of labor (U>U*)
- Y = Y*  U=U*
U* = non-accelerating inflation rate of unemployment

2. Expected Inflation
- some workers/firms raise wages in advance of inflation

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-4


Overall Effect on Wages

Change in = Output-gap + Expectational


money wages effect effect

For example:

• Y>Y* excess labor demand 2% wage increases


• 3% due to expected wages
• total money wages = 2% + 3% = 5%

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-5


How do people form their
expectations?

- forward-looking?
- backward-looking?
- a combination of both?

APPLYING ECONOMIC CONCEPTS 30.1


How Do People Form Their
Expectations?

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-6


From Wages to Prices

Overall effect on nominal wages determines how the AS curve


shifts
 impact on price level

Supply-
Actual Expected
= Output-gap + + shock
inflation inflation inflation inflation

The last term captures any shifts in the AS curve caused by


things other than wage changes.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-7


Constant Inflation

If inflation has been constant for several years and there is no


indication of an impending change in monetary policy:
 expected inflation will equal actual inflation

If expected inflation equals actual inflation:


 Y must equal Y*  no output gap

But if there is no output gap, what is causing the inflation?

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-8


Figure 30.2 Constant Inflation
without Supply Shocks

Constant inflation
with Y=Y* occurs
when the rate of
monetary growth,
the rate of wage
increase, and
expected inflation
are all consistent
with the actual
inflation rate.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-9


Figure 30.3 A Demand Shock
without Validation

Demand Shocks

Demand inflation results


from a rightward shift in the
AD curve.

A demand shock that is not


validated produces only
temporary inflation.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-10


Figure 30.4 A Demand Shock
with Validation

With monetary validation:


-the AD curve shifts
further to the right
- keeping open the
inflationary gap

Continued validation
turns a transitory inflation
into sustained inflation.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-11


Figure 30.5 A Supply Shock with
and without Validation

Supply Shocks
If wages fall only
slowly (when Y<Y*),
the return to Y* after
a non-validated
negative supply
shock will be slow.

Monetary validation of
a negative AS shock
causes the initial rise in
P to be followed by a
further rise.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-12
Is Monetary Validation of Supply
Shocks Desirable?

One potential danger of validation:


- a wage-price spiral could be created

Once started, a wage–price spiral can be halted only if the


Fed stops validating the supply shocks that are causing the
inflation.

But the longer it waits to do so, the more firmly held will be
the expectations that it will continue its policy of validating
the shocks.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-13


Accelerating Inflation

Question:
What happens to inflation if the central bank tries to maintain
an inflationary gap through continued monetary validation?

Answer:
Inflation will accelerate.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-14


Expectational Effects

The acceleration hypothesis:


- as long as an inflationary gap persists, expectations
of inflation will be rising
 increases in the rate of inflation

Implications of rising expected inflation:

• To hold real GDP constant, expansionary monetary


policy is needed to shift the AD curve at an increasingly
rapid pace to offset the increasingly rapid shifts in the
AS curve.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-15
Inflation as a Monetary Phenomenon

The causes of inflation:

1. Anything that increases AD will cause P to rise.

2. Anything that increases factor prices will decrease AS


and cause P to rise.

3. Unless continual monetary expansion occurs, such


increases in P must eventually come to a halt.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-16


Inflation as a Monetary Phenomenon

The consequences of inflation:

1. In the short run, demand inflation tends to be


accompanied by an increase in output above Y*.
2. In the short run, supply inflation tends to be
accompanied by a decrease in output below Y*.
3. When costs and prices have fully adjusted, shifts in
either AD or AS affect P but leave output unchanged.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-17


Inflation as a Monetary Phenomenon

EXTENSIONS IN THEORY 30.1


The Phillips Curve and Accelerating
Inflation

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-18


Inflation as a Monetary Phenomenon

Conclusions about inflation:

1. Without monetary validation, positive AD shocks


cause temporary inflation, and output returns to Y*.
2. Without monetary validation, negative AS shocks
cause temporary inflation, and output returns to Y*.
3. Inflation initiated by either AD or AS shocks can only
be sustained with continuing monetary validation.

 Sustained inflation is always a monetary phenomenon!

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-19


Reducing Inflation

The Process of Disinflation

Reducing inflation is often costly


– lost output and unemployment

Expectations can cause inflation to persist even after its


original causes have been removed.

Crucial factor:
- how quickly inflation expectations are revised
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-20
Figure 30.6 Eliminating a
Sustained Inflation
Phase 1: Removing
Monetary Validation
Begin with a reduction
in the rate of monetary
expansion.

Starting at E1,
suppose the central
bank stops increasing
the money supply.
The AD curve stops shifting
- but inflation expectations keep AS curve shifting
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-21
Phase 2: Stagflation

Stagflation caused by
continued shifts in AS
curve:
- slow-to-adjust
expectations
-wage momentum

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-22


Phase 3: Recovery

Eventually, recovery
takes output to Y*, and P
is stabilized:
Either wages fall,
bringing the AS curve
back to AS2 …
…or the central bank
increases the money
supply sufficiently to shift
the AD curve to AD2.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-23


Figure 30.7 The Cost of
Disinflation: the Sacrifice Ratio

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-24


Conclusion

Throughout the history of economics, inflation has been


recognized as a harmful phenomenon.

The high inflation rates that the United States experienced


in the 1970s and early 1980s were also experienced in
many other developed countries.

Some commentators have argued that inflation is now


“dead.” One of the reasons is the process of globalization
that has exerted greater competitive forces to keep
inflationary pressures at bay.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-25


The Death of Inflation?

APPLYING ECONOMIC CONCEPTS 30.2


The Death of Inflation?

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 30-26

S-ar putea să vă placă și