Lecture 9 Topic 9

Question 1

Inflation = ?

Answer 1

An increase in the general price level in the economy

Question 2

When does inflation tend to be lower?

Answer 2

During recessions (high unemployment)

Question 3

Upward spikes in inflation during…

Answer 3

Economic crises

Question 4

Inflation tends to be higher in…

Answer 4

Poorer countries

Question 5

What measures the general level of prices that consumers have to pay for goods & services?

Answer 5

The consumer price index (CPI)

Question 6

What is CPI based on?

Answer 6

Based on a representative bundle of consumer goods - “cost of living”

Question 7

What is the common measure of inflation?

Answer 7

Change in CPI

Question 8

GDP deflator = ?

Answer 8

A measure of the level of prices for domestically produced output (ratio of nominal to real GDP)

Tracks prices of components of GDP (C, I, G, MX)

Allows GDP to be compared across countries and over time

Question 9

Zero inflation = ?

Answer 9

A constant price level from year to year

Question 10

Deflation = ?

Answer 10

A general decrease in the general price level

Question 11

Disinflation = ?

Answer 11

A decrease in the rate of inflation

Question 12

Real interest rate = ?

Answer 12

Nominal interest rate - inflation rate

Interest rate when taking into account the impact of inflation

Question 13

For people on fixed nominal income, higher inflation means what for the value of their income?

Answer 13

It means their income is lower in actuality

Question 14

What impact does inflation have on the real value of debt?

Answer 14

Inflation reduced the real value of debt

This is good for borrowers but bad for creditors

Question 15

High rate of inflation is good or bad for the economy?

Answer 15

High inflation makes the economy work less well, bad

High inflation leads to uncertainty

it’s harder for producers to distinguish between changes in relative prices and inflation

Question 16

Why is deflation consequential?

Answer 16

When prices are falling, households will postpone consumption as they expect it’ll be cheaper in the future

Question 17

What are wages & prices determined by?

Answer 17

Determined by interactions between firms, consumers and workers

Question 18

Inflation may be due to…?

Answer 18

Increases in bargaining power of firms over their consumers

Increases in the bargaining power of workers over firms, due to higher bargaining power or employment

Question 19

Higher employment results in …

Answer 19

Inflation

Because it increases workers bargaining position
- higher wages (to incentivise workers to work as they can find another job easily)
- higher cost of production (so firms can still profit after giving higher wages)
- higher prices (so firms can still profit)

Question 20

An upswing in business cycle is often associated with…?

Answer 20

Rising inflation

Higher aggregate demand = higher employment = higher wages = higher cost of production = higher prices

Question 21

Prices are stable when…?

Answer 21

When the labour market is in equilibrium

Labour market being the employment market

Question 22

Bargaining gap = ?

Answer 22

The difference between the real wage required to incentivise effort, and the real wage that gives firms enough profits to stay in business

Question 23

Unemployment is below equilibrium leads to…?

Answer 23

A positive bargaining gap and inflation

Question 24

Unemployment is above equilibrium leads to…?

Answer 24

A negative bargaining gap and deflation

Question 25

Labour market equilibrium leads to…?

Answer 25

The bargaining gal is zero and the price level is constant

Question 26

A positive bargaining gap in boom =

Answer 26

Inflation

Question 27

A negative bargaining gap in recession =

Answer 27

Deflation

Question 28

Keeping unemployment too low leads to…?

Answer 28

Higher prices but also rising inflation

Question 29

Supply shock = ?

Answer 29

Unexpected change in the supply-side on the economy

E.g. oil price shocks

Supply shock is another cause of high and rising inflation

Question 30

Increase in the price of oil leads to…

Answer 30

Downward shift of the price-setting curve

Prices rise

Real wages fall

Positive bargaining gap

Persistently higher inflation

Question 31

How do the central bank establish market interest rates?

Answer 31

They work backwards

Choose the desired level of aggregate demand, based on the labour market equilibrium

Estimate the real interest rate, which will produce this level of aggregate demand

Calculate the nominal policy rate that will produce the appropriate market interest rate

Question 32

Exchange rate = ?

Answer 32

Number of units of home currency that can be exchanged for one unit of foreign currency

Question 33

What impact do interest rates have on the foreign exchange market?

Answer 33

Impacts the exchange rate (currency appreciation/depreciation)

Question 34

What does exchange rate impact?

Answer 34

Relative demand for home-produced goods, so affects net exports

Therefore, interest rates affect aggregate demand through the market for financial assets

Question 35

How does exchange rate as transmission mechanism work?

Answer 35

Fall in investment = fall in aggregate demand (AD) = fall in forecast inflation

E.g. Australia central bank cuts interest rate = fall in demand for Australian bonds = fall in demand for AUD = depreciation of AUD = exports become cheaper & imports more expensive = increase in X-M = increase in AD

Question 36

Phillips curve = ?

Answer 36

Shows the trade off between inflation and unemployment

Question 37

Positive bargaining gap leads to ..?

Answer 37

Persistently high inflation

Question 38

How can central banks stabilise the economy?

Answer 38

By changing the policy rate

Question 39

What are the 4 channels of monetary transmission mechanism?

Answer 39

Interest rate
Asset prices
Profit expectations
Exchange rstes

Question 40

What puts a limitation on monetary policy?

Answer 40

Zero lower bound