Lecture10 inflation

650 views

Published on

Lecture 10: inflation
Macro Economic by Mankew.
Prepare by: Dr. Giang Thanh Long at National Economics University

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
650
On SlideShare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
20
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Lecture10 inflation

  1. 1. 19/08/2012 10 Causes of Inflation and the Philips Curve Causes of InflationDefinition and Measurement Definition: Inflation is a continuous increase in the general price level. Measurement: Percentage change in the general price level. πt = [( Pt - Pt-1)/ Pt-1].100 (%) General price level: measured by either Consumer Price Index (CPI) or GDP deflator (DGDP). 1
  2. 2. 19/08/2012 Category of Inflation Mild inflation High inflation: Hyper inflation: According to Philip Cagan, inflation rate being from 50% per month to 13.000% per year. Figure 1 Inflation in the US, 1960-2002 16 14 12 10 % per year 8 6 4 2 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 inflation rate inflation rate trend Vietnam’s CPI in 2008 Chỉ số giá tháng 10 năm 2008 so với (%) Chỉ số giá 10 tháng đầu năm Kỳ gốc Tháng 10 Tháng 12 Tháng 9 2008 so với cùng kỳ năm năm 2005 năm 2007 năm 2007 năm 2008 2007CHỈ SỐ GIÁ TIÊU DÙNG 148,20 126,72 121,64 99,81 123,15I. Hàng ăn và dịch vụ ăn uống 172,14 140,56 132,12 99,58 136,95Trong đó: 1- Lương thực 201,99 160,06 151,41 98,09 149,58 2- Thực phẩm 161,16 132,82 124,44 100,01 133,05 3. Ăn uống ngoài gia đình 169,86 139,54 131,37 100,47 131,92II. Đồ uống và thuốc lá 128,32 113,27 111,34 100,67 110,21III. May mặc, mũ nón, giầy dép 126,05 112,55 110,82 100,70 109,81IV. Nhà ở và vật liệu xây dựng (*) 148,40 122,84 116,76 98,92 122,39V. Thiết bị và đồ dùng gia đình 125,94 111,99 111,26 100,73 108,36VI. Dược phẩm, y tế 123,00 109,76 108,75 100,58 108,72VII. Phương tiện đi lại, bưu điện 138,44 124,82 119,56 99,06 116,66 Trong đó: Bưu chính viễn thông 83,46 89,21 90,39 99,82 88,44VIII. Giáo dục 115,02 106,71 106,56 100,69 103,63IX. Văn hoá, thể thao, giải trí 115,74 109,50 109,30 100,38 105,03X. Đồ dùng và dịch vụ khác 132,35 114,65 111,69 6 100,85 113,11 2
  3. 3. 19/08/2012 Typical Hyper inflation in the World Germany Russia China Greece Hungary Bolivia NicaraguaBegin 8/1922 12/1921 2/1947 11/1943 8/1945 4/1984 4/1987End 11/1923 1/1924 3/1949 11/1944 7/1946 9/1985 3/1991No. of months 16 26 26 13 12 18 48Ratio of 1,02(1010) 1,24(105) 4,15(106) 4,7(108) 3,81(1027) 1028,5 5,53(105)begin/end priceAverage inflationrate per month 322 57 79,7 365 19800 48,1 46,45(%)Highest inflationrate per month 32400 213 919,9 85,5(106) 41,9(1015) 182,8 261,15(%) Money growth and inflation in four typical inflation Period Monthly Money Inflation rate growth % % Germany 8/1922 => 11/1923 322% 314% Greece 11/1943 => 11/1944 365% 220% Hungary 8/1945 => 7/1946 19,800% 12,200% Poland 1/1923 => 1/1924 81.4% 72.2% Source: Philip Cagan: The Monetary Dynamics of Hyperinflation, in Milton Friedman, ed., Studies in the Quantity Theory of Money (Chicago: University of Chicago press, 1956), p.26 INTERNATIONAL COMPARISON OF MONEY AND PRICE INDICES (1990-2003) Annual growth Annual growth Annual growth Country of GDP deflator of CPI of food price Vietnam 11.6 2.8 - China 4.9 6.0 11.3 The Philippines 7.7 7.3 6.7 Indonesia 15.3 13.9 16.1 Malaysia 3.4 3.1 4.3 Thailand 3.4 4.1 4.6 South Korea 4.8 4.5 4.8 Singapore 0.6 1.3 1.4 Source: WDI 2005 3
  4. 4. 19/08/2012 Theories of Inflation A. Causes of inflation 1. Demand-pull inflation: An increase in aggregate demand 2. Cost-push inflation: An increase in prices of factors of production. Examples: • An increase in wage level. • An increase in input prices 3. Inertial inflation 10 Fig.2 Demand-pull Fig.3 Cost-push inflation inflation PP AS1 AS1 E1 AS0P2 P1 AD2 P0P1 E0 AD1 AD0 AD0 Y1 Y* Y Y* Y2 Y 11 Figure 4 Inertial inflation P AS3 AS2 AS1 P3 P2 P1 AD3 AD2 AD1 Y* Y 12 4
  5. 5. 19/08/2012 B. Monetary approach to inflation • Central insight: Changes in money supply is the root cause of changes in the general price level. • M. Friedman: “Inflation is always and everywhere a monetary phenomenon... and it occurs only when money grows faster than does output” • Quantity theory of money: MV = PY V = V So: % change in P (π) = = % change in M - % change in Y Monetary approach to inflation • Policy implications: Tightening money supply is a core solution to control inflation. Tightening fiscal policy, too. Fig.5 International data on money growth and inflationInflation rate 10,000 Democratic Republic(percent,logarithmic Nicaragua of Congoscale) Angola 1,000 Georgia Brazil 100 Bulgaria 10 Kuwait Germany 1 USA Canada Oman Japan 0.1 0.1 1 10 100 1,000 10,000 Money supply growth (percent, logarithmic scale) Data for more than 100 countries in 1990s: Average growth of M1 and π 5
  6. 6. 19/08/2012 Fig.6 Money growth and inflation in typical hyper inflation cases 10000 1000percent growth 100 10 1 Israel Poland Brazil Argentina Peru Nicaragua Bolivia 1983-85 1989-90 1987-94 1988-90 1988-90 1987-91 1984-85 inflation growth of money supply 16 Inflation in Vietnam, 1987-2004 1987- 1990- 1995- 2000- 1987- 1989 1994 1999 2004 2004 Growth of CU 286.9 44.8 25.9 27.3 78.9 Growth of M1 286.9 44.8 25.9 27.3 78.9 Growth of M2 318.3 43.5 27.2 22.7 84.3 Openness degree 44.9 57.2 75.3 104.9 71.6 GDP growth rate 4.77 7.30 7.51 7.23 6.90 Inflation rate by CPI 217.2 34.3 6.02 4.33 48.3 Inflation rate by DGDP 281.1 36.4 9.38 3.76 63.9 Fig.7 Inflation rate and money growth rate in Vietnam, 1988-2004 900 800 700 600 500 400 300 200 100 0 -100 87 89 91 93 95 97 99 01 03 19 19 19 19 19 19 19 20 20 L m phát M2 6
  7. 7. 19/08/2012 Inflation Tax (IT) and Seiniorage (SE)• Seiniorage is the revenue earned by government from printing money. ∆M ∆M M P = P + ∆P M P P + ∆P• Inflation tax: Inflation reduces purchasing power of money in circulation. M M P + ∆P − P ∆P M P − =M = P P + ∆P P( P + ∆P) P P P + ∆P ThuÕ ®óc tiÒn ë mét sè n−íc, 1975-90* N−íc % so víi nguån thu ngoµi % GDP thuÕ ®óc tiÒn Mü 6,02 1,17 Canada 6,61 1,26 Anh 5,31 1,91 Italia 28,00 6,60 Ph¸p 7,19 2,73 §øc 3,85 1,08 Bolivia** 139,5 5,00 Brazil 18,36 4,13 Chile 7,48 2,39 Ê n ®é 14,30 1,81 Hµn quèc 10,70 1,84 Mªhic« 18,70 2,71 Philippines 7,79 0,99 Thai lan 7,06 0,94 Thæ nhÜ kú 24,40 5,09 Vªnzuela 10,76 3,05 Peru 29,71 4,92 Israel 24,55 2,99 *TÝnh trung b×nh n¨m **cña giai ®o¹n 1977-1985 20Nguån : J. D. Sachs and F. Larrain, Macroeconomics in the Global Economy, trang 341.Inflation and economic growth relation T. Killick (1981): U-turn shape relation between inflation and economic growth: − Inflation has positive impacts on economic growth at a low level, while it has negative impacts on econ. growth at high level. M. Khan and A. Senhadji (2000), with data on 140 countries in the period 1960-1998: Inflation has an influence on the threshold of economic growth. The range of optimal inflation rate is: − 1-3% per year for industrial countries, and − 7-11% per year for developing countries 7
  8. 8. 19/08/2012 Fig.8 U-turn shape relation between inflation and economic growth gY gYmax π* πControlling inflation• Tightened fiscal policy • Reducing G or LAS P increasing T results in a reduction in Y and P. SAS • Costs of reducing Po E1 inflation is lower Y and P1 Eo higher U ADo AD1 Y1 Y0 YControlling inflation• Tightened monetary policy • Contractionary LAS P monetary policy results SAS in higher interest rate, Po E1 which in turn reduces investment, and thus Y. P1 Eo ADo • Costs of reducing inflation is lower Y and AD1 higher U Y1 Y0 Y 8
  9. 9. 19/08/2012 The Short-Run Tradeoff between Inflation and Unemployment : Philips Curve Unemployment and Inflation• The natural rate of unemployment depends on various features of the labor market.• Examples include minimum-wage laws, the market power of unions, the role of efficiency wages, and the effectiveness of job search.• The inflation rate depends primarily on growth in the quantity of money, controlled by the Fed. Unemployment and Inflation• Society faces a short-run tradeoff between unemployment and inflation.• If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation.• If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment. 9
  10. 10. 19/08/2012 THE PHILLIPS CURVE • The Phillips curve illustrates the short-run relationship between inflation and unemployment. Figure 9 The Phillips Curve Inflation Rate(percentper year) 6 B A 2 Phillips curve 0 4 7 Unemployment Rate (percent) Aggregate Demand, Aggregate Supply, and the Phillips Curve • The Phillips curve shows the short- run combinations of unemployment and inflation that arise as shifts in the aggregate demand curve move the economy along the short-run aggregate supply curve. 10
  11. 11. 19/08/2012 Aggregate Demand, Aggregate Supply, and the Phillips Curve • The greater the aggregate demand for goods and services, the greater is the economy’s output, and the higher is the overall price level. • A higher level of output results in a lower level of unemployment. Figure 8 How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips CurvePrice InflationLevel Short-run Rate aggregate (percent supply per year) 6 B 106 B 102 A High A aggregate demand 2 Low aggregate Phillips curve demand 0 7,500 8,000 Quantity 0 4 7 Unemployment (unemployment (unemployment of Output (output is (output is Rate (percent) is 7%) is 4%) 8,000) 7,500) SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF EXPECTATIONS • The Phillips curve seems to offer policy-makers a menu of possible inflation and unemployment outcomes. 11
  12. 12. 19/08/2012 The Long-Run Phillips Curve • In the 1960s, Friedman and Phelps concluded that inflation and unemployment are unrelated in the long run. • As a result, the long-run Phillips curve is vertical at the natural rate of unemployment. • Monetary policy could be effective in the short run but not in the long run. Figure 9 The Long-Run Phillips Curve Inflation Rate Long-run Phillips curve High B 1. When the inflation Fed increases the growth rate of the money supply, the rate of inflation 2. . . . but unemployment increases . . . A remains at its natural rate Low in the long run. inflation 0 Natural rate of Unemployment unemployment Rate Figure 10 How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve Price Long-run aggregate Inflation Long-run Phillips Level supply Rate curve 1. An increase in 3. . . . and the money supply increases the increases aggregate inflation rate . . . B P2 demand . . . B2. . . . raisesthe price Alevel . . . P A AD2 Aggregate demand, AD 0 Natural rate Quantity 0 Natural rate of Unemployment of output of Output unemployment Rate 4. . . . but leaves output and unemployment at their natural rates. 12
  13. 13. 19/08/2012Expectations and the Short-Run Phillips Curve• Expected inflation measures how much people expect the overall price level to change.• In the long run, expected inflation adjusts to changes in actual inflation.• The Fed’s ability to create unexpected inflation exists only in the short run. • Once people anticipate inflation, the only way to get unemployment below the natural rate is for actual inflation to be above the anticipated rate.Expectations and the Short-Run Phillips Curve Unemployment Rate = Natural rate of unemployment - a Actual − Expected inflation inflation ( ) • This equation relates the unemployment rate to the natural rate of unemployment, actual inflation, and expected inflation. Figure 11 How Expected Inflation Shifts the Short-Run Phillips Curve 2. . . . but in the long run, expected inflation rises, and the short-runInflation Phillips curve shifts to the right. Rate Long-run Phillips curve C B Short-run Phillips curve with high expected inflation A Short-run Phillips curve 1. Expansionary policy moves with low expected the economy up along the inflation short-run Phillips curve . . . 0 Natural rate of Unemployment unemployment Rate 13
  14. 14. 19/08/2012 The Natural Experiment for the Natural-Rate Hypothesis • The view that unemployment eventually returns to its natural rate, regardless of the rate of inflation, is called the natural-rate hypothesis. • Historical observations support the natural-rate hypothesis. The Natural Experiment for the Natural Rate Hypothesis • The concept of a stable Phillips curve broke down in the in the early ’70s. • During the 1970’s and 1980’s, the economy experienced high inflation and high unemployment simultaneously. Figure 12 The Phillips Curve in the 1960s Inflation Rate(percent per year) 10 8 6 1968 4 1966 1967 2 1965 1962 1964 1961 1963 0 1 2 3 4 5 6 7 8 9 10 Unemployment Rate (percent) 14
  15. 15. 19/08/2012 Figure 13 The Breakdown of the Phillips Curve Inflation Rate(percent per year) 10 8 6 1973 1971 1969 1970 1968 1972 4 1966 1967 2 1962 1965 1964 1961 1963 0 1 2 3 4 5 6 7 8 9 10 Unemployment Rate (percent) SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS• Historical events have shown that the short-run Phillips curve can shift due to changes in expectations.• The short-run Phillips curve also shifts because of shocks to aggregate supply. • Major adverse changes in aggregate supply can worsen the short-run tradeoff between unemployment and inflation. • An adverse supply shock gives policymakers a less favorable tradeoff between inflation and unemployment. SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS • A supply shock is an event that directly alters the firms’ costs, and, as a result, the prices they charge. • This shifts the economy’s aggregate supply curve. . . • . . . and as a result, the Phillips curve. 15
  16. 16. 19/08/2012 Figure 14 An Adverse Shock to Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve Price Inflation Level AS2 Rate 4. . . . giving policymakers Aggregate a less favorable tradeoff supply, AS between unemployment and inflation. B P2 B3. . . . and 1. An adverseraises A shift in aggregate Athe price P supply . . .level . . . PC2 Aggregate demand Phillips curve, P C 0 Y2 Y Quantity 0 Unemployment of Output Rate 2. . . . lowers output . . . SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS • In the 1970s, policymakers faced two choices when OPEC cut output and raised worldwide prices of petroleum. • Fight the unemployment battle by expanding aggregate demand and accelerate inflation. • Fight inflation by contracting aggregate demand and endure even higher unemployment. Figure 15 The Supply Shocks of the 1970s Inflation Rate (percent per year) 10 1981 1975 1980 1974 1979 8 1978 6 1977 1973 1976 4 1972 2 0 1 2 3 4 5 6 7 8 9 10 Unemployment Rate (percent) 16
  17. 17. 19/08/2012THE COST OF REDUCING INFLATION• To reduce inflation, the Fed has to pursue contractionary monetary policy.• When the Fed slows the rate of money growth, it contracts aggregate demand.• This reduces the quantity of goods and services that firms produce.• This leads to a rise in unemployment. Figure 16 Disinflationary Monetary Policy in the Short Run and the Long Run 1. Contractionary policy moves the economy down along theInflation short-run Phillips curve . . . Long-run Rate Phillips curve A Short-run Phillips curve with high expected inflation C B Short-run Phillips curve with low expected inflation 0 Natural rate of Unemployment unemployment 2. . . . but in the long run, expected Rate inflation falls, and the short-run Phillips curve shifts to the left. THE COST OF REDUCING INFLATION• To reduce inflation, an economy must endure a period of high unemployment and low output. • When the Fed combats inflation, the economy moves down the short-run Phillips curve. • The economy experiences lower inflation but at the cost of higher unemployment. 17
  18. 18. 19/08/2012THE COST OF REDUCING INFLATION • The sacrifice ratio is the number of percentage points of annual output that is lost in the process of reducing inflation by one percentage point. • An estimate of the sacrifice ratio is five. • To reduce inflation from about 10% in 1979- 1981 to 4% would have required an estimated sacrifice of 30% of annual output! Summary• The Phillips curve describes a negative relationship between inflation and unemployment.• By expanding aggregate demand, policymakers can choose a point on the Phillips curve with higher inflation and lower unemployment.• By contracting aggregate demand, policymakers can choose a point on the Phillips curve with lower inflation and higher unemployment. Summary• The tradeoff between inflation and unemployment described by the Phillips curve holds only in the short run.• The long-run Phillips curve is vertical at the natural rate of unemployment. 18
  19. 19. 19/08/2012 Summary• The short-run Phillips curve also shifts because of shocks to aggregate supply.• An adverse supply shock gives policymakers a less favorable tradeoff between inflation and unemployment. Summary• When the Fed contracts growth in the money supply to reduce inflation, it moves the economy along the short-run Phillips curve.• This results in temporarily high unemployment.• The cost of disinflation depends on how quickly expectations of inflation fall. 19

×