Lecture 9 Topic 9 Flashcards
Inflation = ?
An increase in the general price level in the economy
When does inflation tend to be lower?
During recessions (high unemployment)
Upward spikes in inflation during…
Economic crises
Inflation tends to be higher in…
Poorer countries
What measures the general level of prices that consumers have to pay for goods & services?
The consumer price index (CPI)
What is CPI based on?
Based on a representative bundle of consumer goods - “cost of living”
What is the common measure of inflation?
Change in CPI
GDP deflator = ?
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
Zero inflation = ?
A constant price level from year to year
Deflation = ?
A general decrease in the general price level
Disinflation = ?
A decrease in the rate of inflation
Real interest rate = ?
Nominal interest rate - inflation rate
Interest rate when taking into account the impact of inflation
For people on fixed nominal income, higher inflation means what for the value of their income?
It means their income is lower in actuality
What impact does inflation have on the real value of debt?
Inflation reduced the real value of debt
This is good for borrowers but bad for creditors
High rate of inflation is good or bad for the economy?
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
Why is deflation consequential?
When prices are falling, households will postpone consumption as they expect it’ll be cheaper in the future
What are wages & prices determined by?
Determined by interactions between firms, consumers and workers
Inflation may be due to…?
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
Higher employment results in …
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)
An upswing in business cycle is often associated with…?
Rising inflation
Higher aggregate demand = higher employment = higher wages = higher cost of production = higher prices
Prices are stable when…?
When the labour market is in equilibrium
Labour market being the employment market
Bargaining gap = ?
The difference between the real wage required to incentivise effort, and the real wage that gives firms enough profits to stay in business
Unemployment is below equilibrium leads to…?
A positive bargaining gap and inflation
Unemployment is above equilibrium leads to…?
A negative bargaining gap and deflation
Labour market equilibrium leads to…?
The bargaining gal is zero and the price level is constant
A positive bargaining gap in boom =
Inflation
A negative bargaining gap in recession =
Deflation
Keeping unemployment too low leads to…?
Higher prices but also rising inflation
Supply shock = ?
Unexpected change in the supply-side on the economy
E.g. oil price shocks
Supply shock is another cause of high and rising inflation
Increase in the price of oil leads to…
Downward shift of the price-setting curve
Prices rise
Real wages fall
Positive bargaining gap
Persistently higher inflation
How do the central bank establish market interest rates?
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
Exchange rate = ?
Number of units of home currency that can be exchanged for one unit of foreign currency
What impact do interest rates have on the foreign exchange market?
Impacts the exchange rate (currency appreciation/depreciation)
What does exchange rate impact?
Relative demand for home-produced goods, so affects net exports
Therefore, interest rates affect aggregate demand through the market for financial assets
How does exchange rate as transmission mechanism work?
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
Phillips curve = ?
Shows the trade off between inflation and unemployment
Positive bargaining gap leads to ..?
Persistently high inflation
How can central banks stabilise the economy?
By changing the policy rate
What are the 4 channels of monetary transmission mechanism?
Interest rate
Asset prices
Profit expectations
Exchange rstes
What puts a limitation on monetary policy?
Zero lower bound
