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
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
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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