Central bank independence an attempt to prevent

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Unformatted text preview: lation also distorts relative prices. •  Taxes –  Based on nominal incomes •  Economic decisions –  Based on real variables •  Tax distortions are more severe when inflation is high. –  Some prices are faster at adjusting to inflation than other prices are. •  Shoe leather costs of inflation –  People want to hold less money when inflation is high. •  Menu costs –  The costs to firms of changing prices frequently. 17 8/4/11 8.5 The Fiscal Causes of High Inflation The Inflation Tax •  The government budget constraint Government funds Tax revenue Changes in the stock of Borrowing money •  Seignorage and the inflation tax –  Names for the revenue that the government obtains from printing more money (ΔM) •  The inflation tax –  Shows up as a rise in the price level –  Is paid by people holding currency •  If a government runs large budget deficits, as debt rises –  Lenders may worry the government will have trouble paying back loans –  They may stop lending to the government altogether. Central Bank Independence •  Monetary Policy –  Conducted by RBA •  Debt solution: Raising taxes? •  Fiscal Policy –  May not be politically feasible –  Treasury •  The government may resort to printing currency to finance its budget. –  Lenders to the government will be paid back in currency that is worth less than the dollars lent. •  Central Bank Independence –  An attempt to prevent fiscal considerations from leading to excessive inflation 18 8/4/11 Case Study: Episodes of High Inflation •  Episodes of high inflation tend to recur. •  Hyperinflations can stop just as quickly as they start. •  Countries experiencing hyperinflation typically raise about 5 percent of GDP from the inflation tax. –...
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