Chapter 16 Flashcards
Inflation
An increase in the overall level of prices
Deflation
A fall in the overall level of prices
The inflation rate is the percentage change in the:
- CPI
- GDP deflator
- Other index of overall price level
Core Inflation
Excludes goods with historically volatile price changes
All-items inflation (headline inflation)
Includes all of the goods that the average consumer buys
What two ways can the economy’s overall pice level be viewed
- As the price of a basket of goods and services
2. As a measure of the value of money
Level of prices in the economy
The overall level of prices adjusts to the level at which demand for money equals the supply
What are the effects of momentary injection
- Short run- output and prices rise
- Workers want higher wage
- Long run- more money supply will lead to higher prices; output stays the same
Quantity theory of money
A theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate
What are real variables
Variables measured in physical units
What is classical dichotomy
The theoretical separation of nominal and real variables
What is monetary neutrality
The proposition that changes in the money supply do not affect real variables
What is the quantity equation
MV = PY
V: velocity of money
Y: Real GDP
P: Price level
M: quantity of money
What is the velocity of money
The number of times that the entire money supply turns over in a given period
What does the quantity equation imply
That increasing the money supply leads to inflation and decreasing the money supply leads to deflation
Leads to the conclusion that price level is immaterial
What are menu costs
The money, time, and opportunity costs of changing prices to keep up with inflation
What are shoe leather costs
The time, money, and effort costs of managing cash in the face of inflation
What is Tax distortion
The fact that tax laws only take into consideration nominal income, not what you can buy with it
What is the nominal interest rate
The reported interest rate that is not adjusted for the effects of inflation
What is the real interest rate
Adjusted for the effects of inflation
Equation for real interest rate
Real interest rate = Nominal interest rate - inflation rate
What is the aggregate price level
A measure of the average price level; in practice, the CPI or GDP price deflator
What are menu costs
The costs of changing prices to keep pace with inflation
What is disinflation
A period in which inflation rates are falling but still positive
What is hyperinflation
Extremely long lasting and painful increases in the price level
What is potential output
The total amount of output a country could produce if all its resources were fully engaged
What is the Phillips curve and what does it show
A model that shows the connection between inflation and unemployment in the short run
It shows that a decrease in unemployment will be accompanied by an increase in inflation in the short run
What is the NAIRU
The lowest possible unemployment rate that will not cause the inflation rate level to increase
What does it mean for output gap to be positive
Competition leads to a rise in the prices of inputs, which means inflation increases
What does it mean if the output gap is negative
Resources are not being fully used. Inflation decreases so central banks will peruse expansionary monetary policy by lowering interest rates, allowing inflation to rise and brining back employment
What does statistics Canada use to measure inflation
Core inflation because it is less likely to reflect shocks to individual product markets and more likely to show economy wide inflation
What does the neutrality of money imply
That if money supply suddenly doubled, nominal GDP would double as well, but real GDP would stay the same
Why do policy makers prefer small amounts of inflation
- little inflation reduces the risk of deflation
- leaves more room for the central bank to engage in expansionary monetary policy
- easier for firms to adjust real wages in response to changing labour demand and supply conditions
What will happen if the central bank pursues aggressive expansionary policy to reduce unemployment
Inflation may spiral out of control. The level of unemployment at which inflation will remain unstable is called the non-accelerating inflation rate of unemployment (NAIRU)
What is the classical theory of inflation
In the long run, increases in money supply lead to increase in money supply only
In the short run, output and prices increase as aggregate demand shifts to the right
