Inflation. The rate of inflation measures the annual percentage increase in prices

Содержание

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Inflation Inflation in historical perspective low inflation in 1950s and 60s

Inflation

Inflation in historical perspective
low inflation in 1950s and 60s
high inflation in

1970s and 80s
low inflation since mid 1990s
most developed countries gear monetary policy to achieving a low target rate of inflation
is this still the case since the financial crisis?
Слайд 3

Annual % increase in GDP deflator Inflation rates in selected industrialised

Annual % increase in GDP deflator

Inflation rates in selected industrialised economies

Notes:

2014 and 2015 based on forecasts; Eurozone = the 17 countries using the euro in 2013
Source: Based on data in World Economic Outlook Database (IMF) and AMECO Database (European Commission, DGECFIN)
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The distinction between real and nominal values. Nominal figures are those

The distinction between real and nominal values.

Nominal figures are those using

current prices, interest rates, etc. Real figures are figures corrected for inflation.
When there is inflation, we have to be careful in assessing how much national output, consumption, wages, etc. are increasing.
GDP in money terms may have risen by 5 per cent, but if inflation is 3 per cent, real growth in GDP will be only 2 per cent.
A rise or fall in inflation is different from a rise or fall in prices.
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Q In a period of rapid inflation which of the following

Q In a period of rapid inflation which of the following

would be the least desirable store of wealth?

Vintage wine.
Property
Money
Land
Stocks and shares]

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Inflation Aggregate demand & supply and prices The level of prices

Inflation
Aggregate demand & supply and prices
The level of prices in the

economy is determined by the interaction of aggregate demand and aggregate supply.
Aggregate demand curve shows how much national output (real GDP) will be demanded at each level of prices.
Слайд 7

O Price level National output Aggregate demand Why the AD curve

O

Price level

National output

Aggregate demand

Why the AD curve slopes downwards
lower price level

leads to higher domestic goods consumption and fewer imports
higher price level tends to cause interest rates to rise: at a given level of Ms, increase in Md leads to higher interest rates, which discourage investment and encourage saving.
price rise erodes value of people’s savings – they save more to compensate.
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Inflation Aggregate demand & supply and prices aggregate demand curve aggregate

Inflation

Aggregate demand & supply and prices
aggregate demand curve
aggregate supply curve
The aggregate

supply curve slopes upwards – at least in the short run. In other words, the higher the level of prices, the more will be produced.
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O Price level National output AS AD Aggregate demand and aggregate

O

Price level

National output

AS

AD

Aggregate demand and aggregate supply

If aggregate demand exceeds aggregate

supply (e.g. by a – b at a price level of P2), price will rise to the equilibrium level, Pe
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Inflation Aggregate demand & supply and prices aggregate demand curve aggregate

Inflation

Aggregate demand & supply and prices
aggregate demand curve
aggregate supply curve
why AS

curves generally slope upwards
equilibrium
shifts in AD and AS curves
AD: if there is a change in any of its components
AS: if there is a rise in labour productivity or capacity of the economy
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Q As the price level in the economy rises, which of

Q As the price level in the economy rises, which of

the following occurs? (i) The quantity of ‘real money’ decreases; (ii) Real aggregate demand decreases; (iii)Total spending in money terms decreases.

(i) only
(ii) only
(i) and (ii)
(i) and (iii)
(i), (ii) and (iii)

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Inflation Causes of inflation demand pull When the AD curve shifts

Inflation

Causes of inflation
demand pull
When the AD curve shifts to the right,

output will rise and unemployment may fall as a result.
However, at the same time, prices will rise.
Firms will respond to the rise in AD partly by raising prices (caused by costs rise as a result of increasing output), and partly by increasing output (there is a move upwards along the AS curve).
Demand pull inflation is caused by continuing rises in aggregate demand.
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Demand-pull inflation O Price level National output AS AD1 P1 Q1

Demand-pull inflation

O

Price level

National output

AS

AD1

P1

Q1

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O Price level National output AS AD1 P1 Q1 AD2 Demand-pull inflation

O

Price level

National output

AS

AD1

P1

Q1

AD2

Demand-pull inflation

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O Price level National output AS AD1 P1 Q1 AD2 P2

O

Price level

National output

AS

AD1

P1

Q1

AD2

P2

A rise in aggregate demand causes a rise in

the price level (and also a rise in real GDP)

Demand-pull inflation

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Inflation Causes of inflation cost push inflation is associated with continuing

Inflation

Causes of inflation
cost push inflation
is associated with continuing rises in costs

and hence continuing leftward (upward) shifts in the AS curve.
Such shifts occur when costs of production rise independently of aggregate demand.
If firms face a rise in costs, they will respond partly by raising prices and passing the costs on to the consumer, and partly by cutting back on production.
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Inflation Rise in costs may come from: wage push increase in

Inflation

Rise in costs may come from:
wage push
increase in wages due

to trade unions activity independently of demand for labour
profit push
firms use their monopoly power to make bigger profits by pushing up prices independently of consumer demand
import-price push
prices rising independently of the level of AD (e.g. OPEC putting up oil prices)
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In all these cases, inflation occurs because one or more groups

In all these cases, inflation occurs because one or more groups

are exercising economic power.
The problem is likely to get worse, therefore, if there is an increasing concentration of economic power over time (e.g. if firms or unions get bigger and bigger, and more monopolistic) or if groups become more militant.

Inflation

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Q Which one of the following would be the cause of

Q Which one of the following would be the cause of

cost-push inflation?

A cut in the rate of income tax.
A cut in the rate of VAT
A cut in interest rates
A rise in the exchange rate
A rise in the price of oil

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Cost-push inflation O Price level National output AS1 AD P1 Q1

Cost-push inflation

O

Price level

National output

AS1

AD

P1

Q1

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O Price level National output AS1 AD P1 Q1 AS2 Cost-push inflation

O

Price level

National output

AS1

AD

P1

Q1

AS2

Cost-push inflation

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O Price level National output AS1 AD P1 Q1 AS2 P2

O

Price level

National output

AS1

AD

P1

Q1

AS2

P2

A rise in costs causes a rise in the

price level (but also a fall in real GDP)

Cost-push inflation

Слайд 23

With the growth in demand for raw materials and food (China,

With the growth in demand for raw materials and food (China,

India, Brazil) rising costs became more of a problem
Thus, what starts with a rise in aggregate demand in these countries (demand-pull inflation), becomes cost-push inflation for other countries due to globalisation, having to pay higher prices for the commodities they import.

Inflation

Слайд 24

Demand-pull and cost-push inflation can occur together since wage and price

Demand-pull and cost-push inflation can occur together
since wage and price rises

can be caused both by increases in aggregate demand
as well as by independent causes pushing up costs.
Even when an inflationary process starts as either demand-pull or cost-push, it is often difficult to separate the two.

Inflation

Слайд 25

The interaction of demand-pull and cost-push inflation O Price level National output AS1 AD1 P1

The interaction of demand-pull and cost-push inflation

O

Price level

National output

AS1

AD1

P1

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O Price level National output AS1 AD1 P1 AS2 AD2 The

O

Price level

National output

AS1

AD1

P1

AS2

AD2

The interaction of demand-pull and cost-push inflation

Слайд 27

O Price level National output AS1 AD1 P1 AD2 P2 AS3

O

Price level

National output

AS1

AD1

P1

AD2

P2

AS3

AD3

AS2

The interaction of demand-pull and cost-push inflation

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Inflation Expectations and inflation Workers and firms take account of the

Inflation

Expectations and inflation
Workers and firms take account of the expected rate

of inflation when making decisions.
The employers will be happy to pay a wage rise somewhat below 5 per cent.
After all, they can put their price up by 5 per cent
Realisation of expectations
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Lecture 4.1 Fiscal and Monetary Policy

Lecture 4.1 Fiscal and Monetary Policy

Слайд 30

Aims of this session: Add Government spending and foreign trade as

Aims of this session:

Add Government spending and foreign trade as additional

components of aggregate demand
Explain what we mean by fiscal and monetary policy
Show how fiscal and monetary policy may affect aggregate demand
Слайд 31

Fiscal policy Fiscal policy is the government’s decisions about spending and

Fiscal policy

Fiscal policy is the government’s decisions about spending and taxes.
Automatic

stabilisers reduce fluctuations in aggregate demand
Слайд 32

UK government spending and taxes (% of GDP)

UK government spending and taxes (% of GDP)

Слайд 33

Government and aggregate demand 1 Government purchases (G) of final output

Government and aggregate demand 1
Government purchases (G) of final output add

directly to aggregate demand:
AD= C + I + G
The level of government demand reflects how many hospitals the government wants to build, how large it wants defence spending to be, and so on.
Слайд 34

Government and aggregate demand 2 Government levies taxes and pays out

Government and aggregate demand 2

Government levies taxes and pays out

transfer benefits
Tax revenue and benefit spending both vary with output.
How do taxes affect disposable income?
Assume net taxes NT = tY
where t is the net tax rate
Households’ disposable income YD is now:
YD = Y(1-t)
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The open economy: foreign trade and output determination Introducing exports (X)

The open economy: foreign trade and output determination

Introducing exports (X)

& imports (Z)
Trade balance
the value of net exports (X - Z)
Trade deficit
when imports exceed exports
Trade surplus
when exports exceed imports
Aggregate demand
AD = C + I + G + X – Z
In equilibrium AD is equal to output and income
Слайд 36

UK Foreign trade (% of GDP)

UK Foreign trade (% of GDP)

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Monetary Policy I Interest rates are the instrument of monetary policy

Monetary Policy I

Interest rates are the instrument of monetary policy
The monetary

instrument is the variable over which a central bank exercises day-to-day control
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Monetary Policy II Monetary policy is the decision by the Central

Monetary Policy II

Monetary policy is the decision by the Central

Bank about what the interest rate to set.
In the UK, the central bank is the Bank of England, which acts on behalf of the government. It has operational independence from the government to set interest rates.
But the Chancellor has decided the Bank’s ultimate objective is to set interest rates to try to keep inflation close to 2 per cent a year
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Nominal vs Real Interest Rates The real interest rate is the

Nominal vs Real Interest Rates
The real interest rate is the difference

between the nominal interest rate and inflation
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Nominal and real UK interest rates (%)

Nominal and real UK interest rates (%)

Слайд 41

How interest rates affect the economy Interest rates influence: personal consumption

How interest rates affect the economy

Interest rates influence:
personal consumption by changing the

cost of borrowing for consumption
investment demand by raising the opportunity cost of capital
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Interest rates and investment demand For a given rate of output

Interest rates and investment demand

For a given rate of output growth

the investment demand schedule II shows how a lower interest rate raises investment demand
If the interest rate rises from r0 to r1 desired investment falls from I0 to I1
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Lower interest rates increase aggregate demand 1 Lower interest rates induce

Lower interest rates increase aggregate demand 1

Lower interest rates induce an

increase in personal consumption and investment demand increasing AD to AD1 and output to Y1
Equivalently, lower interest rates increase desired investment at any output
but also, by reducing desired consumption, they raise the desire to save at any output
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