Lecture 7 Notes.docx - Inflation It\u2019s causes and costs HISTORY OF INFLATION \u2022 What has been the average inflation rate over the past 60 years in

Lecture 7 Notes.docx - Inflation Itu2019s causes and costs...

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Inflation: It’s causes and costs HISTORY OF INFLATION What has been the average inflation rate over the past 60 years in Australia? And over the past 10 years? What was the inflation rate in the 1970s? Did we ever observe deflation? Why? Disinflation is a decrease in the rate of inflation Hyperinflation is generally defined as inflation that exceeds 50 per cent per month
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INFLATION Inflation is an increase in the overall level of prices. Deflation is a decrease in the overall price level. Hyperinflation is an extraordinarily high rate of inflation. THE CAUSES OF INFLATION If P is the price of goods and services, measured in terms of money, then 1/ P is the value of money measured in terms of goods and services. When the overall price level rises, the value of money falls. The demand and supply of money determine the value of money . What is the ‘easiest’ way to create high inflation? Milton Friedman ‘Inflation is always and everywhere a monetary phenomenon.’ What does he mean? The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate. MONEY SUPPLY The money supply is a policy variable that is controlled by the central bank. Through instruments such as open-market operations, the central bank directly controls the quantity of money supplied by the banking system. (Mankiw has removed the word, 'directly' Note that the RBA no longer targets the money supply. The RBA now targets interest rates and inflation. 2
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MONEY DEMAND Money demand has several determinants, including interest rates and the average level of prices in the economy. People hold money because it is the medium of exchange. The amount of money people choose to hold depends on the prices of goods and services . THE CLASSICAL DICHOTOMY AND MONETARY NEUTRALITY Nominal variables are variables measured in monetary units. Real variables are variables measured in constant units. This separation is the classical dichotomy. According to the classical dichotomy, different forces influence real and nominal variables. Real economic variables do not change with changes in the money supply.
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