INFLATION , TYPES OF INFATION, CONTROLLING INFLATION

1. Inflation
fishers effect and phillips curve( Relation between unemployement & inflation)
By Vishal

2. Money and prices during inflation
 Hyperinflation is inflation that exceeds 50 percent per month.
 Hyperinflation occurs in some countries because the government prints too
much money to pay for its spending.

3. Figure 4 Money and Prices During Four Hyperinflations
Copyright © 2004 South-Western
(a) Austria (b) Hungary
Money supply
Price level
Index
(Jan. 1921 = 100)
Index
(July 1921 = 100)
Price level
100,000
10,000
1,000
100
19251924192319221921
Money supply
100,000
10,000
1,000
100
19251924192319221921

4. Figure 4 Money and Prices During Four Hyperinflations
Copyright © 2004 South-Western
(c) Germany
1
Index
(Jan. 1921 = 100)
(d) Poland
100,000,000,000,000
1,000,000
10,000,000,000
1,000,000,000,000
100,000,000
10,000
100
Money
supply
Price level
19251924192319221921
Price level
Money
supply
Index
(Jan. 1921 = 100)
100
10,000,000
100,000
1,000,000
10,000
1,000
19251924192319221921

5.  The Fisher effect refers to a one-to-one adjustment of the nominal interest
rate to the inflation rate.
 According to the Fisher effect, when the rate of inflation rises, the nominal
interest rate rises by the same amount.
 The real interest rate stays the same.
Fishers effect

6. Inflation & Phillips curve:
The inflation rate is the percentage
change in the price level.
The Phillips Curve shows the
relationship between the inflation rate
and the unemployment rate.

7. Philips Curve:
 It is a statistical relationship between unemployment and money wage
inflation.
 Rate of inflation= rate of wage growth less rate of productivity growth.

8. The Philips Curve
Wage growth %
(Inflation)
Unemployment (%)
The Phillips Curve shows an
inverse relationship between
inflation and unemployment. It
suggested that if governments
wanted to reduce unemployment
it had to accept higher inflation as
a trade-off.
Money illusion – wage rates rising
but individuals not factoring in
inflation on real wage rates.
1.5%
6%4%
2.5%
PC1

9.  The curve crosses the horizontal axis at a positive
value of unemployment. Hence it is not possible to
have zero inflation and zero unemployment
 The concave shape implies that lower the level of
unemployment higher the rate of inflation.
 Govt. should be able to use demand management
policies to take the economy to acceptable levels of
inflation and unemployment.
 In order to achieve full employment, some inflation
is unavoidable.
 However, this relationship broke down at the end of
1960s when Britain began to experience rising
inflation and unemployment.
 This raised a question on the application of Phillips
curve in the long run.

10.  inflation
The Augmented Philips Curve
Unemployment
Long Run PC
PC1
PC2PC3
Assume the economy starts with an inflation rate of
1% but very high unemployment at 7%.
Government takes measures to reduce
unemployment by an expansionary fiscal policy that
pushes AD to the right (see the AD/AS diagram on
slide 15)
7%
2.0%
1.0%
There is a short term fall in unemployment but at a
cost of higher inflation. Individuals now base their
wage negotiations on expectations of higher inflation in
the next period. If higher wages are granted then firms
costs rise – they start to shed labour and
unemployment creeps back up to 7% again.
3.0%
To counter the rise in unemployment,
government once again injects resources
into the economy – the result is a short-
term fall in unemployment but higher
inflation. This higher inflation fuels further
expectation of higher inflation and so the
process continues. The long run Phillips
Curve is vertical at the natural rate of
unemployment. This is how economists
have explained the movements in the
Phillips Curve and it is termed the
Expectations Augmented Phillips
Curve.

11.  7% becomes the natural rate in this case.
 Whenever unemployment rate is pushed below natural rate , wages
increase, pushing up costs. This leads to a lower level of output which
pushes unemployment back to the natural rate.