Notes

Owen Luis
Dr. E P 2 100/100
8 December 2017
Module 33
Vocabulary
Classical model of the price level - according to this, the real quantity of money is always at its long-run equilibrium level
Inflation tax - a reduction in the value of money held by the public caused by inflation
Cost-push inflation - inflation that is caused by a significant increase in the price of an input with economy-wide importance
Demand-pull inflation - inflation that is caused by an increase in aggregate demand
Money and Inflation
Even moderate levels of inflation can have complex causes
An increase in the money supply increases real GDP by lowering the interest rate and stimulating investment spending and consumer spending
In the long run, real GDP falls back to its original level
Other things equal, an increase in the money supply by a given percent will increase the overall price level by the same percent
In the long run, a change in the nominal money supply, M, leads to a change in the aggregate price level, P, that leaves the real quantity of money, M/P, at its original level
When analyzing large changes in the aggregate price level, macroeconomists often find it useful to ignore the distinction between the short run and the long run
In the long run, money is neutral
Workers and businesses are sensitized to inflation, so they are quick to raise their wages and prices in response to changes in the money supply, which does not occur under low inflation rates
Because of this, the classical model of the price level is a good approximation of reality for economies experiencing persistently high inflation
Nothing stops a government from printing money in order to cover its expenses; in fact, they do it all the time
The US government can and does raise revenue by printing money
Seignorage refers to the right to stamp gold and silver into coins; an alternative way to look at this is to say that the right to print money is itself a source of revenue
People who currently hold money pay for the goods and services the government purchases with newly printed money; inflation erodes the purchasing power of their money holdings, essentially causing them to pay unknowingly
During the times of German hyperinflation, people often burned paper money, since it was less valuable than wood
Hyperinflation occurs exponentially and is self-reinforcing, therefore allowing it to easily spiral out of control
Moderate Inflation and Disinflation
Using the aggregate demand and supply model, we can see that there are two possible changes that can lead to an increase in the aggregate price level: a decrease in aggregate supply or an increase in aggregate demand
Inflation caused by a significant increase in the price of an input with economy-wide importance is called cost-push inflation
Leftward shift of the aggregate supply
Inflation caused by an increase in aggregate demand is known as demand-pull inflation
Rightward shift of the aggregate demand
Potential output typically grows steadily over time, reflecting long-run growth
When actual aggregate output is equal to potential output, the actual unemployment rate is equal to the natural rate of unemployment
When the output gap is positive (an inflationary gap), the unemployment rate is below the natural rate; when the output gap is negative (a recessionary gap), the unemployment rate is above the natural rate
Module Summary
The classical model of the price is a graph used to describe the relationship between aggregate price level and real GDP during periods of extreme inflation. It does so by ignoring the distinction between the short run and the long run, simplifying the process without sacrificing much accuracy. Governments which print money in order to pay off all their debt impose inflation taxes upon their citizens, leading to high rates of inflation or even hyperinflation. Cost-push inflation is caused by a significant increase in the price of an input with economy-wide importance, leading to a leftward shift of the aggregate supply curve. Conversely, demand-pull inflation is caused by an increase in aggregate demand, which results in a rightward shift of the aggregate demand curve.
CYU
The value of money in an economy with low inflation is much higher than that of an economy with high inflation. The low inflation economy will take much more significant effect from the change in money supply while the high inflation economy will hardly change, if at all. Because of this, the classical model of the price level is accurate in over-inflated economies since the short run and the long run respond to money supply changes essentially identically.
There can still be an inflation tax since this tax applies to currently held currency, not currency which is to be spent or obtained.
TTT-MC
The real quantity of money is
equal to M/P.
the money supply adjusted for inflation.
higher in the long run when the Fed buys government securities
A - I only
In the classical model of the price level
C - only the long-run aggregate supply curve is vertical.
The classical model of the price level is most applicable in
B - periods of high inflation.
An inflation tax is
C - the result of a decrease in the value of money held by the public.
Revenue generated by the government’s right to print money is known as
A - seignorage.
TTT-FR


Module 34
Vocabulary
Short-run Phillips curve - represents the negative short-run relationship between the unemployment rate and the inflation rate
Nonaccelerating inflation rate of unemployment (NAIRU) - the employment rate at which inflation does not change over time
Long-run Phillips curve - shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience
Debt deflation - the reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation
Zero bound - applies to the nominal interest rate, meaning it cannot go below zero
Liquidity trap - a situation in which conventional monetary policy is ineffective because nominal interest rates are up against the zero bound
Inflation and Unemployment in the Long Run
The short-run trade-off between unemployment and inflation is that lower unemployment tends to lead to higher inflation, and vice versa
There is a negative short-run relationship between the unemployment rate and the inflation rate
The natural rate of unemployment rate is 6% and a rise of 1 percentage point in the output gap causes a fall of ½ percentage point in the unemployment rate
This is a predicted relationship known as Okun’s law
Changes in aggregate supply also affect the Phillips curve
In general, a negative supply shock shifts SRPC up, and a positive supply shock shifts it down
The expected inflation rate is the most important factor affecting inflation other than the unemployment rate
The expected rate of inflation is the rate that employers and workers expect in the near future
This affects the SRPC because workers and employers must agree upon higher wages to compensate, since hiring workers later is more expensive
Because of this, an increase in expected inflation shifts the short-run Phillips curve upward: the actual rate of inflation at any given unemployment rate is higher when the expected inflation rate is higher
The SRPC says that at any given point in time there is a trade-off between unemployment and inflation
Policy makers may either accept high inflation rates to achieve low unemployment, or reject high inflation rates and pay the price of high unemployment
Most macroeconomists believe there is no trade-off between these two in the long run; it is not possible to achieve lower unemployment in the long run by accepting higher inflation
To avoid accelerating inflation over time, the unemployment rate must be high enough that the actual rate of inflation matches the expected rate of inflation
The unemployment rate at which inflation does not change over time is referred to as the nonaccelerating inflation rate of unemployment (NAIRU)
The long-run Phillips curve demonstrates the relationship between unemployment and inflation in the long run, after expectations of inflation have had time to adjust to experience
It is vertical because any unemployment rate below the NAIRU leads to ever-accelerating inflation
The NAIRU is another name for the natural rate of unemployment; this is the level of unemployment the economy “needs” in order to avoid accelerating inflation
Once the public has come to expect continuing inflation, bringing it down is painful
To reduce inflationary expectations, policy makers need to adopt contractionary policies to keep the unemployment rate above the natural rate for an extended period of time
This process of bringing down inflation that has been ingrained in expectations is known as disinflation
Disinflation can be incredibly expensive; to retreat from the US’s high inflation in the 1980s would cost $2.6 trillion today
Deflation
Before WWII, deflation – a falling aggregate price level – was just as common as inflation
Under deflation, borrowers lose and lenders gain
The real burden of a borrower’s debt rises
A dollar in the future has greater value than a dollar in the present, so lenders benefit
The effect of deflation in reducing aggregate demand (known as debt deflation) played a significant role in the Great Depression
Nominal interest rate cannot drop below 0% because lenders do not pay borrowers on their debt
This is an example of a zero bound
Situations where monetary policy is ineffective can occur; this is a result of the nominal interest rates being up against the zero bound, and is known as a liquidity trap
Occurs when there is a sharp reduction in demand for loanable funds, which is exactly what happened during the Great Depression
After WWII, when inflation became the norm around the world, the zero bound problem largely vanished as the public came to expect inflation rather than deflation
Module Summary
In the Phillips curve, the short-run tradeoff between inflation and unemployment consists of a direct negative relationship. However, in the long run, this tradeoff does not exist, because it is not possible to achieve lower unemployment in the long run by accepting higher inflation. Eradicating inflation, known as disinflation, is no easy task, and is notorious for having exorbitant costs. In situations regarding low, but still positive inflation rates, problems arise such as the zero bound regarding the nominal interest rate, which was a huge problem during the Great Depression, since deflation was nearly just as common as inflation in those times.
CYU
A decrease in aggregate demand leads to decreased price levels in attempt to attract buyers, resulting in lower inflation rates and higher unemployment rates.
As expectations of the inflation rate change, the unemployment rate will move to a new equilibrium.
Contractionary policies must be adopted in order to run the process in reverse for extended periods of time; this cost can be reduced if policy makers explicitly state their determination to reduce inflation.
Lending money at a negative nominal rate of interest is essentially paying someone to borrow your money. This creates problems because contractionary money policy cannot be used when the nominal interest rate has a zero bound.
TTT-MC
The long-run Phillips curve is
the same as the short-run Phillips curve.
vertical.
the short-run Phillips curve plus expected inflation.
B - II only
The short-run Phillips curve shows a _____ relationship between _____.
C - negative, unemployment and inflation
An increase in expected inflation will shift
B - the short-run Phillips curve upward.
Bringing down inflation that has become embedded in expectations is called
E - disinflation.
Debt deflation is
E - all of the above.
TTT-FR
a. The nominal interest rate if expected inflation were 0% would be 4%
b. The nominal interest rate if expected inflation were -2% would be 2%, because 4 – 2 = 2
c. The nominal interest rate if expected inflation were -6% would be 0%, because nominal interest rate has a zero bound and cannot go below 0% or else nobody would lend money.
d. If nominal interest rate were negative, lenders would be paying borrowers to take their money, so no lending would take place because it would cost money to lend.
e. Nominal interest rates of 0% makes the use of monetary policy to lower the interest rate ineffective; this is called a liquidity trap.
Video Notes

Story
Graphs/ Comment
1981 Quell Inflation
Inflation was the domestic priority
They wanted the economy to grow while keeping the unemployment rate low
Most Americans expected the inflation rate to stay the same for a long time
When bonds and stocks don’t work during inflation you need to go out and buy things
They began to borrow all they could borrow to spend as much as they could
There was a new tight money policy that would counteract the interest rates
If the tax cuts are too big the interest rates were to go very high and they indeed did exactly that
The economy headed into an inflation
The inflation rate began to drop so they had to ease monetary policy

The american economy did pretty well compared to what had happened during WWII
By 1980 they thought the government would not be able to reduce inflation
They had to fight inflation but also that they would not fight inflation that hard
Only unexpected policies will most likely be harmful to the economy
The people believed that the high inflation would stay like that all the time

2) 1985 International trade makes solving domestic problems more difficult
There was no side affects to policies that the government would choose to impose
Many americans were being created in services but many manufacturing jobs were going overseas
American policy makers were having problems because the jobs were going overseas
Many people working in the manufacturing were being laid off and losing their fucking jobs
The trade deficit was huge and the American dollar was a main cause of this as was believed
Many of the economist and Americans believed that everyone would benefit from free trade

The numbers have gotten so big that the graph is very useful
We can’t separate the domestic policies with the international ones
Exports were to expensive and imports were too cheap
There are many variables to take into account
In order to maintain economic stability we must take into account many variables that make it much harder for us to fix it.

3) 2008-$700 billion Bank bailout
The house bubble was about to blow up
The housing market collapsed and many investment companies failed
The banking industry was on the verge of collapse
Many houses were being sold in foreclosure
They had an unorthodox plan to use the American tax
THe government had to do something that was called TART
Government began to invest into banks in order to not let the banks fail and cause the economy to go to straight shit

They believed that the TARP was terrible
The US tax payers dollars was used to bail out a lot of banks
They believed that the fat cats took all the money
The fed may have gained some profits from the program
Most of the money used was dispersed into loans and most of the loans were paid back

4) Stabilization Are we still in control? Explain
We are in control most of the time but if the economy gets to a really bad point there is little that the fed can do to make it better. Sometimes the economy needs to heal itself and bring itself back up to good states

Hyperinflation is Venezuela’s biggest enemy because that is what is destroying their economy. High inflation rates will leave Venezuelan money worthless, and the country will be unable to import goods eventually.

To stop the inflationary spiral, the article suggests that the President focuses on the inflation problems and working to fix it, instead of letting other people decide what to do and focusing on becoming reelected in later years. They also suggest on reducing public spending to get the deficit under control and and other measures to rebuild trust in Venezuelan currency.

The government policies are negatively affecting business in Venezuela. Their government has imposed stiff price controls and stringent foreign exchange rules that are forcing merchants to sell their goods at a loss.


Consumers have lost trust in Venezuelan currency and have rushed to change their currency for US dollars. They are scared and some policies have caused panic.