Chapter 9: Inflation

Question 1

Causes of inflation:

Answer 1

1. Cost-push inflation:
   results from either a temporary negative supply shock or a push by workers for wage hikes that are beyond those justified by productivity gains
2. Demand-pull inflation:
   results when policymakers pursue policies that increase aggregate demand
3. Budget deficits:
   Can be the source only if the deficit is persistent and is financed by creating money rather than by issuing bonds

Question 2

Effects of inflation

Answer 2

1. Positive effects: (6)
   - Benefit to inflators
   - Early and first reciepients of the inflated money
   - Big cartels, destroy small sellers
   - Borrowers
   - Inflation may reduce the severity of economic recession
   - Tobin effects (can increase investment)
2. Negative effects: (12)
   - Hoarding
   - Distortion of relative prices
   - Increased risk - higher uncertainties
   - Income diffusion effect
   - Existing creditors will be hurt
   - Fixed income recipients will be hurt
   - Increased consumption ratio at the early stages of inflation
   - Lower national saving
   - Illusion of making profit
   - Cause mal-investment, tax bracket & business cycles
   - Currency debasement
   - Rising price of imports

Question 3

Solutions to Inflation

Answer 3

1. Fiscal policy:
   involves decisions about government spending and taxation
2. Monetary policy:
   the management of money and interest rates (conducted by the central bank)