Week 7 Inflation Flashcards
(45 cards)
If there is unexpectedly high inflation, is this good for lenders or borrowers and why?
This is good for borrowers as the real interest rate is lower.
What happens if inflation is uncertain?
There is then uncertainty in the credit market so they function inefficiently.
What does the Phillip’s curve state?
The Phillips curve states that inflation and unemployment have an inverse relationship. Higher inflation is associated with lower unemployment and vice versa.
In a Phillip’s curve model, what should a central bank do if it believes that inflation is too high?
Increase the nominal interest rate target.
What is forward guidance and when is it used?
Is it used by promising higher inflation in the future to increase inflation and output today. Is is used when the nominal interest rate is already 0%, so cannot be lowered any more.
What is Calvo pricing?
Where each firm has a random opportunity to change its price each period.
In the basic NK model, if a firm was able to reset its price today, it will do so based on what?
What is best for the current period but also on what it believes will be the optimal price in future periods
How can we write the Phillips curve?
i = bi’ + a(Y-Ym)
In the Phillips curve, what should we assume about a and b and what do these stand for:
• i
• i’
• Ym
- a>0
* 0<b></b>
If anticipated future inflation is to increase by 1%, what is the effect on current inflation?
Current inflation will increase by less than 1%.
How do we write the Fisher equation?
r = R - i’
What is the equation linking consumption and investment with real interest rates (the IS/output demand equation)?
Y − Ym = −α (r − r*)
If the central bank changes the nominal rate of interest, is its affect on the real interest rate 1 to 1?
Yes
So if we assume i’ is exogenous and equal to the target (0), what happens if r = r*, and what is the significance of this?
If r =r, then Y = Ym and R = R.
Therefore as long as r = r*, the output gap will be equal to 0 (note that this doesn’t mean that output will be constant).
What does r* stand for and what is it?
The natural rate of interest is the interest rate consistent with maintaining economic growth at its trend rate and stable inflation.
Do we assume that the marginal cost of a departure from the inflation target increases or decreases?
We assume that the marginal cost of a departure from the inflation target increases: ie a 1% increase in the actual inflation is more costly if the inflation rate is 10% than if it is 3%.
What is the dual mandate given to the Fed?
The US government telling the Fed to care about price stability, but also “full employment”.
If a central bank has to choose between a its achieving its output target or its inflation target, what should it do?
The optimal policy is the intermediate point between the 2 targets.
What does an increase in expected inflation do to the Phillips Curve?
An increase in expected inflation causes the Phillips Curve to shift upwards, as we can see from the equation: i = bi’ + a(Y-Ym)
Why could a temporary increase in z cause an increase in Ym?
Because a temporary increase in Ym would shift the output supply curve to the right; thus forming a new equilibrium with Yd.
From starting at equilibrium when there is an increase in expected inflation, what should policy makers do?
Increase the nominal interest at more than one-to-one than the expected increase in inflation. This allows an intermediary point to be found between the output and inflation targets.
What does a persistent increase in govt spending do to the IS curve?
It shifts it to the right.
For r* to change, what should happen?
An exogenous aspect should come into play to lead to a change in r*, eg a change in technology.
What does an increase in expected inflation do to real interest rates if the central bank does nothing and why?
Due to the Fisher equation (nom IR= real IR + i’), if i’ rises, than real interest rates must fall.