Inflation, un employment and monetary policy Flashcards
what are the descriptive analysis for this?
- why inflation matters
- what causes inflation
philips curve with and without expectation
what is the prescriptive analysis?
- can monetary policy be used to stabilise economy?
what is inflation?
increase in general price level (GPI or deflator)
what is the consumer price index?
measures consumer price inflation
what is zero inflation?
constant price level
what is deflation?
decrease in general price
what is rising inflation?
inflation rate rises in successive years
why does inflation mater?
it is an indicator of macro economy
what happens when thee is ridings inflation
gov
ruling party more lily to lose votes
people want it low
rising inflation consumers?
real living costs are higher, consumer in a static state, may cut down on consumption
people with nominal debt will benefit but people with nominal assets will lose (spend more today)
rising inflation firms?
uncertainty leads to higher menu costs and bounded rationality
what are menu costs
cost to a firm resulting from changing
e.g. printing new menus
what is meany by nominal?
has not been adjusted for inflation
what causes inflation?-
- increase in bargaining power of firms over consumers i the output market (degree of competition)
- increase in bargaining power of workers over firm in the input market (wages rise) (cost push inflation)
- exogenous shocks (rising oil forces etc)
what is cost push inflation?
when firms respond to rising costs by increasing prices (such as wages)
what is the phillips curve?
shows the relationship between unemployment and inflation
inverse relationship one moves up and other down
what happens if there is positive relationship in the phillips curve?
there is a trade off
lower unemployment but higher inflation
what is meant by expectations in the phillips curve?
expectations can influence how we behave today
hw can expectations impact wide economy?
- price expectations impact wage demands (protect real income by bidding for pay rise)
- major purchases (if inflation decreasing may wait for a few months to buy)
- if price declines then phillips curve shifts inwards
what is money illusion?
occurs when people confuse nominal and real values when making economic decisions, only illusion is most likely to occur when inflation is unanticipated, so that peoples expectations of inflation turn out to be some distance from the correct level
what happens in the PC without expectations?
- forms maximise profits by setting nominal wages in the inout market and nominal prices in out put market
- workers only cares about real wage as this represents actual purchainsc power, as nominal price can dampen actual wages
- in booms firm needs to set higher wages to attract workers
- higher wages means higher costs for firms so the marketing department will raise prices to cover these
how can disappointment from workers occur?
as when firms raise nominal price and nominal wage the actual price stays the same
what is a wage price spiral?
continuous rise in prices which forces wages
increase wages, increase disposable income, increase demand, increase price
to summarise what happens when there is a boom, recession and equilibrium?
without expectation
B: U is low and positive inflation
R: U is high and negative deflation
what is the bargaining gap?
difference between real wage required to incentivise effort and real wage that gives firms enough profits to stay in business
what does a steeper slope on philips curve mean?
more difficult in trading inflation for unemployment
need a lot of one to trade
what does the phillips curve with inflation explain?
why inflation still uses when givernments try to keep unemployment low
- people are forward looking
how are people forward looking?
take actions now in anticipation of things they expect to happen, expectation matters
how do people treat prices as messages?
expectations formed on based of change in force
what is the phillis curve summarised?
- determined by bargaining gap during business cycles
- accelerated by forward looking expectations
what is ttje monetary policy?
can we make inflation fluctuate less
action of central bank can take to influence how much money is in the economy and how much it costs to borrow
involves using interest rates and other tools to influence levels of consumer spending and aggregate demand
stabilise the economic cycle
what are ways in which monetary policy can be implemented?
- market interest rate (on loans etc, if high they won’t do it so spend less and inflation low)
- asset prices(higher dedication means that spend less)
- exchange rates and international trading (if it is more then won’t do it, less goods may lower demand as it will be higher process)
what is expansionary monetary policy?
expand money supply and boost economic activity by keeping interest rates low and econourage borrowing
what is confectionary monetary policy?
central bank uses monetary policy to increase interest rates and reduce money supply
what is the zero lower bound of MP?
when interest rates can’t fall any further that below 0%
uk is 0.5
- central bank can no longer stimulate economy through interest rates creating a liquidity trap
what is a liquidity trap?
interest rates are low and saving rates are high
what are polices to over come the liquidity trap?
- higher i inflation (incentivises people to spend as much money as in the bank its not worth much
- fiscal policy, direct inaction fo spending int economy, demand rises economic growth fiscal policy essential if MP fails
fiscal = rise in gov borrowing
why should we use MP?
keynsian
- people are weak, so we should stimulate economy in order to fix it
- worker well until 1973 oil riss
this is when people started to have expectations
why shouldn’t we use MP?
friedman
- toaist - do nothing let nature achieve the balance
