Chapter 16 Flashcards
Disinflation
A reduction in the inflation rate
A change in the nominal money supply
leads in the long run to a change in the aggregate price level that leaves the real quantity of money, at its original level
Classical model of the price level
The real quantity of money is always at its long-run equilibrium level
In the long run, money is ___________
neutral
The classical model of the price level is a better approximation of reality for economies experiencing _____________
high inflation
SRAS shifts more quickly back to long run
The FED __________ the debt by creating money and buying the debt back from the public through open-market purchases of Treasury bills.
monetizes
Economists refer to the revenue generated by the government’s right to print money as _______________, an archaic term that goes back to the middle ages
seignorage
Inflation tax
The reduction in the value of money held by the public caused by inflation
Real seignorage =
(∆M/M) x (M/P)
Rate of growth of the money supply x Real money supply
Potential output
The level of real GDP that the economy would produce once all prices had fully adjusted
When actual aggregate output is equal to potential output, _____________________________
the actual unemployment rate is equal to the natural rate of unemployment
When the output gap is positive (inflationary gap), the unemployment rate is _______
below the natural rate
When the output gap is negative (recessionary gap), the unemployment rate is ______________
above the natural rate
Fluctuations of aggregate output around the long-run trend of potential output correspond to ___________________
fluctuations of the unemployment rate around the natural rate
Okun’s law
The negative relationship between the output gap and cyclical unemployment
short-run Phillips curve
The negative short-run relationship between the unemployment rate and the inflation rate
When unemployment rate is low
inflation is high
When unemployment rate is high, _______
inflation is low
expected inflation rate
the rate of inflation that employers and workers expect in the near future
*second most important factor affecting inflation
Expectations about future inflation ___________________
directly affect the present inflation rate
An increase in the expected inflation shifts _______________
the short-run Phillips curve upward
Stagflation
Combination of above-average unemployment rates coupled with inflatioin rates unprecedented
To avoid accelerating inflation over time, __________________________________________
The unemployment rate must be high enough that the actual rate of inflation matches the expected rate of inflation
Nonaccelerating inflation rate of unemployment
“NAIRU”
The unemployment rate at which inflation does not change over time
Long-run Phillips curve
Shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience
Why is the LRPC vertical?
Any unemployment rate below the NAIRU leads to ever-accelerating inflation
Any unemployment rate above the NAIRU leads to decelerating inflation
Natural rate of unemployment
The portion of the unemployment rate unaffected by the swings of the business cycle
Another definition for NAIRU relationship with natural rate
The level of unemployment the economy needs in order to avoid accelerating inflation is equal to the natural rate of unemployment
Disinflation
The process of bringing down inflation that is embedded in expectations
Core inflation rate
The annual rate of change in the “core” consumer price index (CPI)
Why is there no long-run trade-off between unemployment and inflation?
Once expectations of inflatin adjust, wages will also adjust, returning employment and the unemployment rate to their equilibrium (natural) levels
Implies Phillips curve is vertical
Why is disinflation so costly?
Aggregate output in the short run must typically fall below potential output
How can we reduce costs of disinflation?
Not allowing inflation to increase in the first place
If central bank is credible and announces in advance its policy to reduce inflation
Deflation
Falling aggregate price level
Who loses from deflation?
Borrowers
Overall effect of deflation?
Reduces aggregate demand => deepening an economic slump
may lead to further deflation
Debt deflation
The reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation
Why does debt deflation occur?
Because borrowers, whose real debt rises as a result of deflation, are likely to cut spending sharply, and lenders, whose real assets are now more valuable, are less likely to increase spending
Zero bound on nominal interest rate
It cannot go below zero
Liquidity trap
When conventional monetary policy (cutting interest rates) is ineffective because nominal interest rates ae up against the zero bound
