Econ+102+lecture+20%2C+3-27-12+-+Money+in+unusual+times copy

Econ+102+lecture+20%2C+3-27-12+-+Money+in+unusual+times...

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Lecture 20: Ch. 16, part 2 - Money in “unusual” circumstances Econ 102, Winter 2012 3/27/2012 1 Required reading : Ch 16: pp. 443-450 pp. 463-466
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Outline 1. Classical macro and price flexibility 2. The inflation tax 3. The proximate causes of hyperinflation 4. The problems of hyperinflation 5. The problems of deflation 3/27/2012 2
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Real effects of inflation Last Thursday, we studied the effects of monetary policy in the “usual” times. A well-defined inflation/unemployment tradeoff Back in chapter 8, we studied the costs of inflation in the “usual” times Things like menu costs, shoeleather costs, etc Argued that mostly, inflation caused reallocations through unexpected changes Today, we study the unusual times when changes in the price level can be very costly. The economic consequences of: 3/27/2012 3
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Classical model of money The classical model of money assumes no “stickiness” Prices are perfectly flexible When the money supply rises, AD shifts outwards Because of the lack of stickiness, the SRAS curve can immediately respond, raising wages and putting the economy back into LR equilibrium The economy jumps from one LR equilibrium to another - No “adjustment,” no business cycle (as generated by market imperfections like sticky prices) 3/27/2012 4
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rGDP P Illustration of a “classical” macroeconomy, assuming the existence of a SRAS to highlight the point 5
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Classical model of money The classical model of money assumes no “stickiness”: wages and P are perfectly flexible, like always being in the LR  Prices immediately increase in response That is, : if M ↑ 10% , then P also ↑ 10% è the real money supply is not affected When the money supply rises, MD immediately shifts out The implication of classical macro: “inflation is always 3/27/2012 6 100 * t t P M P ΔP M ΔM =
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Classical model of money In the short run of “normal times” with low inflation, this may not be a particularly apt model Wages are nominally sticky – it may take employers or employees a while to “feel the pain” of inflation given constant nominal wages, there are contracts to honor, etc. In “unusual times”, this can be a very useful model In high inflation times, 1. real wages are falling very quickly, (and so demands to adjust quickly are high) 2. people are unwilling to bind themselves to contracts given uncertainty, etc. 3/27/2012 7
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Figure 16.4: Consumer Prices in Zimbabwe, 1999–2008 8
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Figure 16.2 Money Supply Growth and Inflation in Zimbabwe 9 3/27/2012
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Inflation tax How does an economy reach such an “unusual” situation as did Zimbabwe?
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This note was uploaded on 02/10/2012 for the course ECON 102 taught by Professor Rossana during the Winter '08 term at University of Michigan.

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Econ+102+lecture+20%2C+3-27-12+-+Money+in+unusual+times...

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