Lecture8_Ch14 - Inflation and Deflation Learning Objec-ves...

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Inflation and Deflation Learning Objec-ves This chapter introduces you to: Concepts and defini4ons of infla4on The long-­‐run rela4onship between money and infla4on Factors determining the growth of money The costs of infla4on Defla4on and the liquidity trap CHAPTER 14 Infla4on and Defla4on
Inflation and Deflation Infla-on and Defla-on Infla4on is measured as the percentage change in prices over a period of 4me, typically one year. A hyperinfla-on is infla4on of more than 50 percent per month (or roughly 13,000 percent per year). A defla-on is a sustained period of nega4ve infla4on. CHAPTER 14 Infla4on and Defla4on
Inflation and Deflation Some Infla-on Rates CHAPTER 14 Infla4on and Defla4on
Inflation and Deflation Infla-on In the long run, infla4on is determined by the growth rate of the money supply. Sustained infla4on means the central bank is expanding the money supply rapidly. Why would a central bank pursue an infla4onary policy? What level of infla4on harms the economy? How does defla4on occur and what are its effects? CHAPTER 14 Infla4on and Defla4on
Inflation and Deflation Money and Infla-on in the Long Run Monetary policy affects real output in the short run, but is neutral in the long run. Monetary policy has its strongest effects on infla4on in the long run. Expenditure and supply shocks cause year-­‐to-­‐ year changes in the infla4on rate. Average infla4on over long periods is closely 4ed to the growth of the money supply. CHAPTER 14 Infla4on and Defla4on
Inflation and Deflation Velocity and the Quan-ty Equa-on The velocity of money is the ra4o of total spending to the money supply; it measures how quickly money circulates through the economy: V = total spending/ M If spending is $500 and the money supply is $100, velocity is 5 = (500/100). CHAPTER 14 Infla4on and Defla4on
Inflation and Deflation Velocity and the Quan-ty Equa-on Total spending is nominal GDP; the price level ( P ) 4mes real output ( Y ): V = PY/M Velocity is how quickly money circulates, or how many 4mes $1 is spent over a year. The quan-ty equa-on of money is the rela4onship among the money supply, velocity and nominal GDP: MV = PY CHAPTER 14 Infla4on and Defla4on
Inflation and Deflation Velocity and Money Demand The concept of velocity is related to the concept of money demand. In equilibrium money demand, M d , and money supply, M , are equal, so we can rewrite the defini4on of velocity as: V = PY / M d The rela4onship says that given the level of nominal GDP, there is an inverse rela4onship between money demand and velocity; increases in money demand reduce velocity. CHAPTER 14 Infla4on and Defla4on
Inflation and Deflation Deriving the Infla-on Rate The infla4on rate is the growth rate of the price level. Since the quan4ty equa4on always holds, the percentage changes of each side are equal: % change in (MV) = % change in (PY) The percentage change in MV is equal to the percentage changes in M and V and similarly for PY : (% change in M) + (% change in V) = (% change in P) + (% change in Y) CHAPTER 14 Infla4on and Defla4on

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