inflation

Examples of inflation in the following topics:

• Using Monetary Policy to Target Inflation

  • Because interest rates and the inflation rate tend to be inversely related, the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting.
  • if inflation appears to be above the target, the bank is likely to raise interest rates.
  • if inflation appears to be below the target, the bank is likely to lower interest rates.
  • This is viewed by inflation targeters as leading to increased economic stability.
  • Assess the use of inflation targets and goals in monetary policy

• Arguments For and Against Inflation Targeting Policy Interventions

  • When inflation falls below this range, the Fed would lower interest rates and raising the money supply in order to push inflation up.
  • Proponents of inflation targeting argue that a volatile inflation rate has negative effects for an economy.
  • Further, inflation targeting is a transparent way to explain interest rate policy and to anchor consumers' expectations about future inflation.
  • Others suggest targeting long-run inflation, which takes the exchange rate into account, rather than the short-term inflation rate.
  • Argue that central banks should maintain inflation targets, Argue that central banks should not maintain inflation targets

• Distribution Effects of Inflation

  • Unexpectedly high inflation tends to transfer wealth from creditors to debtors and from the rich to the poor.
  • When there is inflation, the value of the money borrowers pay back is less.
  • When inflation is expected, it has few distribution effects between borrowers and lenders.
  • This is because the inflation rate is built in to the nominal interest rate, which is the sum of the real interest rate and expected inflation.
  • Part of the reason that lenders charge interest is to recoup the cost of inflation over time.

• The Short-Run Phillips Curve

  • The short-run Phillips curve depicts the inverse trade-off between inflation and unemployment.
  • The Phillips curve depicts the relationship between inflation and unemployment rates.
  • As unemployment rates increase, inflation decreases; as unemployment rates decrease, inflation increases.
  • When the unemployment rate is 2%, the corresponding inflation rate is 10%.
  • As unemployment decreases to 1%, the inflation rate increases to 15%.

• Introduction to Inflation

  • The reasons for inflation depend on supply and demand.
  • In Keynesian economics, there are three types of inflation.
  • Demand-pull inflation is inflation that occurs when total demand for goods and services exceeds the economy's capacity to produce those goods.
  • One major reason for cost-push inflation are supply shocks.
  • Built-in inflation is the result of adaptive expectations.

• Relationship Between Expectations and Inflation

  • In contrast, anything that is real has been adjusted for inflation.
  • However, suppose inflation is at 3%.
  • As aggregate demand increases, inflation increases.
  • Now, if the inflation level has risen to 6%.
  • Efforts to lower unemployment only raise inflation.

• The Long-Run Phillips Curve

  • In the long run, inflation and unemployment are unrelated.
  • When unemployment is above the natural rate, inflation will decelerate.
  • Consequently, an attempt to decrease unemployment at the cost of higher inflation in the short run led to higher inflation and no change in unemployment in the long run.
  • According to the theory, the simultaneously high rates of unemployment and inflation could be explained because workers changed their inflation expectations, shifting the short-run Phillips curve, and increasing the prevailing rate of inflation in the economy.
  • Although the economy starts with an initially low level of inflation at point A, attempts to decrease the unemployment rate are futile and only increase inflation to point C.

• The Phillips Curve

  • The Phillips curve shows the inverse relationship between inflation and unemployment: as unemployment decreases, inflation increases.
  • The Phillips curve relates the rate of inflation with the rate of unemployment.
  • The Phillips curve argues that unemployment and inflation are inversely related: as levels of unemployment decrease, inflation increases.
  • The Phillips curve shows the inverse trade-off between inflation and unemployment.
  • In this image, an economy can either experience 3% unemployment at the cost of 6% of inflation, or increase unemployment to 5% to bring down the inflation levels to 2%.

• Measuring Inflation

  • The percent change in the CPI over time is the inflation rate.
  • This means that the inflation rate between the base period and the current period was 2.4%.
  • In everyday life, we experience inflation as a loss in the purchasing power of money.
  • When inflation is steady, incomes will generally compensate for the effects of inflation by rising or falling at approximately the same rate as the general price level.
  • Money saved as currency, however, will lose its value if inflation occurs .

• The Taylor Rule

  • The rule stipulates how much a central bank should change the nominal interest rate (real rate plus inflation) in response to changes in inflation, output, or other economic conditions.
  • In particular, the rule stipulates that for each one-percent increase in inflation, the central bank should raise the nominal interest rate by more than one percentage point.
  • The factors that the Taylor rule suggests taking into account when setting inflation-adjusted short-term interest rates are:
  • Expansionary policies with low interest rates are recommended by the Taylor rule in times when the economy is slow (i.e. unemployment is high, or inflation is low).
  • For example, in times of stagflation, inflation may be high while unemployment is also high.