KW_Macro_Ch_16_Sec_01_Money_and_Inflation

KW_Macro_Ch_16_Sec_01_Money_and_Inflation - chapter 16 >...

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>> Inflation, Disinflation, and Deflation Section 1: Money and Inflation chapter 16 Even though inflation in the United States is much lower today than it was during the 1970s—and a far cry from the recent experience of Brazil—the American public and media still pay close attention to inflation. Ask any American to name some serious problems that an economy faces and chances are you’ll hear the word inflation. Yale University economist Robert Shiller did something similar in the mid-1990s, and indeed, he found that Americans consider inflation to be a problem. Three-quarters of those surveyed thought that “inflation hurts my real buying power; it makes me poorer.” And over half of the respondents thought that “preventing high inflation is an important national priority, as important as preventing drug abuse or preventing deterioration in the quality of our schools.”
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2 CHAPTER 16 SECTION 1: MONEY AND INFLATION However, Shiller found that professional economists rarely shared these concerns. Only 12% of the economists surveyed thought that inflation makes them poorer, and only 18% considered preventing inflation an important national priority. Why do economists tend to differ so much from the general public in their impres- sions about inflation, at least at the moderate levels encountered in countries such as the United States? The answer lies in people’s perception of how inflation affects them. People often view inflation as reducing the value of their pay raises; however, economists argue that inflation leads to higher nominal pay increases and therefore doesn’t automatically reduce households’ purchasing power. But even economists who do not consider a moderate level of inflation to be a serious problem still believe there can be costs associated with it. To understand the true costs of inflation, we first need to analyze its causes. As we’ll see later in this chapter, moderate levels of inflation such as those experienced in the United States—even the double-digit inflation of the late 1970s—can have com- plex causes. But very high inflation is always associated with rapid increases in the money supply. To understand why, we need to revisit the effect of changes in the money supply on the overall price level. Then we’ll turn to the reasons governments sometimes increase the money supply very rapidly. Money and Prices, Revisited In Chapter 14 we learned that in the short run an increase in the money supply increases real GDP by lowering the interest rate and stimulating investment spending and consumer spending. However, in the long run, as nominal wages and other sticky prices rise, real GDP falls back to its original level. So in the long run, any given per- cent increase in the money supply does not change real GDP. Instead, other things equal, it leads to an equal percent rise in the overall price level; that is, the prices of
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This note was uploaded on 04/10/2008 for the course ECONOMICS 103 taught by Professor Sheflin during the Spring '08 term at Rutgers.

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KW_Macro_Ch_16_Sec_01_Money_and_Inflation - chapter 16 >...

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