chapte13 - Ch 13: Inflation, relating to Unemployment and...

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Ch 13: Inflation, relating to Unemployment and Growth I. Understanding Inflation A. Distributional effects of Inflation Assuming constant output, inflation affects those on fixed income the most. 1. Pensioners, welfare or Social Security recipients, non-union workers (assuming the nominal payments remain fixed and are not adjusted annually to account for inflation) 2. On the other hand, some inflation can be beneficial to profits (input prices are “stickier” than retail prices) and union workers (new contracts can be negotiated at higher inflation expectations). 3. Since interest rates lag price changes, Real interest rate (Nominal interest rate – inflation) will be lower due to inflation. Savers and lenders are hurt and debtors benefit. If you are a debtor, the real value of the money to pay back when it’s due is less than you thought it would be when it was borrowed. Lenders (owners of debt obligations; for them someone else’s debt is their asset), holders of cash and others negatively affected by inflation experience an “inflation tax” or loss of purchasing power due to the inflation. 4. Deflation will redistribute real wealth in the opposite direction described in 1,2, and 3 above. B. Defining Expectations Expectations about the future of the price-level in the economy can be of several types, or be a mix of more than one type. 1. Rational Expectations: this means that people will make production and purchasing decisions that tend to confirm what economists have predicted, not because every person has read the predictions but because the economic conditions that concern them (such as price signals for specific output – goods – or inputs) will compel their decisions to result in the predicted inflation rate. 2. Adaptive Expectations: decisions are made with a view of inflation that is based on the recent historical levels, such as a weighted average of the last five years inflation rates. 3.
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This note was uploaded on 08/04/2008 for the course ECON 1A taught by Professor Patyk during the Spring '08 term at Foothill College.

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chapte13 - Ch 13: Inflation, relating to Unemployment and...

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