14.3 Reducing Inflation Flashcards
What is Disinflation?
Disinflation
A reduction in the rate of inflation.
What are two notable periods of disinflation for Canada?
In 1981–1982, when inflation fell from more than 12 percent to 4 percent
In 1990–1992, when inflation fell from 6 percent to less than 2 percent.
The process of reducing inflation can be divided into three phases. What are they?
In the first phase, the monetary validation is stopped and any inflationary gap is eliminated.
In the second phase, the economy still suffers from declining output and rising prices—stagflation.
In the final phase, the economy experiences both increasing output and increasing prices, but the inflation then comes to an end.
What does removing monetary validation do?
This policy action slows the rate at which the AD curve is shifting upward.
What is an extreme case of menetary tightening?
An extreme case of monetary tightening in this setting is one where the Bank of Canada adopts a “cold-turkey approach”:
Interest rates are increased so much that the growth rate of the money supply is reduced to zero and the upward shift of the AD curve is halted abruptly.
What does a tight money policy do?
If the excess demand from the inflationary output gap were the only influence on nominal wages, what would the effect of removing monetary policy be?
Other then excess demand, what to wages also depend on?
As we explained earlier, wages depend not only on current excess demand but also on inflation expectations.
What is the effect of inflation expectation in the process of disinflation?
Once inflation expectations have been established, it is not always easy to get people to revise them downward, even in the face of announced changes in monetary policies.
Hence, the AS curve continues to shift upward, causing the price level to continue to rise and output to fall. A recessionary gap is created. The combination of rising prices and a reduction in output (or its growth rate) is called stagflation.
In the face of stagflation, what does the ease with which the BoC can end inflation depend on?
The ease with which the Bank of Canada can end such an inflation depends on how easy it is to change these expectations of continued inflation.
This change is more difficult to the extent that expectations are backward-looking and easier to the extent that expectations are forward-looking.
What happens to inflation if most people are backward-looking when forming their expectations?
If most people are backward-looking when forming their expectations, inflation will remain high even well after the Bank of Canada has implemented its tight monetary policy.
In this case, the AS curve will continue shifting upward and the stagflation will endure.
What happens during stagflation if most people are forward-looking and the Bank’s policy announcements are credible?
if most people are forward-looking and the Bank’s policy announcements are credible, the change in the Bank’s policy will be widely acknowledged and expected inflation will fall relatively quickly.
In this case, the upward shifts of the AS curve will soon come to an end.
What does the percistence of inflation after the inflationary gap has been removed, and the depth of the associated recessionary gap during the stagflationary phase depend on?
The persistence of inflation after the inflationary gap has been removed, and the depth of the associated recessionary gap during the stagflationary phase, depend on how quickly inflation expectations are revised downward.
How does the BoC attempt to inflence expectations?
By making regular speaches and announcements in an attempt to anchor inflation expectations.
What is the final phase of disinflation?
Recovery
The final phase is the return to potential output.