week 9 Flashcards
how do you calc inflation?
we calc the annual percentage change in price level
what is the CPI
consumer price index is a measure of consumer prices to international standards
what is consumer price index housing
▶ A measure of consumer prices which includes owner occupier’s housing costs
▶ Has been the headline measure of UK inflation since 2017
used to target inflation
what is retail price index?
▶ A measure of retail prices
▶ Always higher than the CPI due to a different construction
what is GDP deflator?
▶ A price measure of all domestically produced goods
what is inflation illusion?
▶ Occurs when people confuse nominal changes in prices with real changes
▶ Economic welfare depends upon real variables, not nominal variables
if nominal prices and incomes increase at the same rate then real income does not change
what is expected inflation?
Expected inflation incurs the following costs
▶ Menu costs for firms to change prices frequently
▶ Fiscal drag as nominal wages increase but tax thresholds do not change
what is unexpected inflation?
- Unexpected inflation incurs additional costs
▶ Fixed income earners
▶ Unintended redistribution of income and wealth
▶ Uncertainty
we can summarise the factors determining inflation using the philips curve how?
▶ Expected inflation π
e
▶ Cyclical unemployment
i.e. demand shocks
▶ Supply shocks like energy price increases
compare classical view and Keynesian in terms of market clearing?
in a classical view they do clear
▶ The economy is at full employment and potential output
▶ Role for supply side policies
in a Keynesian view they do not clear
▶ Especially the labour market
▶ More scope for the government to influence the macroeconomy
▶ Role for demand side policies
explain the speed of adjustment for the different types of economists
( new classical macroeconomists, gradualist monetarists, moderate Keynesians, extreme Keynesians)
- New Classical Macroeconomics
▶ Instantaneous market clearing
▶ Rational expectations - Gradualist Monetarists
▶ Full employment will be restored within a few years
▶ The main effect of more money is higher prices - Moderate Keynesians
▶ Economy will eventually get back to full employment
▶ But wage and price adjustment is fairly sluggish - Extreme Keynesians
▶ Markets fail to clear in the short-run
▶ And fail to clear even in the long-run
what is classical dichotomy?
theory stating that real and nominal variables in an economy can be analyzed separately, particularly in the long run
suggests that changes in the money supply primarily affect nominal variables like prices and wages, while real variables like output and employment are determined by real factors like productivity and technology
what is monetary neutrality?
▶ Irrelevance of monetary changes for real variables
claims that the Central Bank does not affect the real economy by
increasing the money supply
what is the classical view versus the Keynesian view to classical dichotomy
classical different forces influence
real and nominal variables Changes in the money supply affect nominal variables like prices and wages but not real variables like employment and real income
opposite for Keynesian as At least in the short-run, the Central Bank can affect the real economy
what impact does expansionary monetary policy have on real income in short vs long run?
No impact on long run as we will observe increase in money supply which leads to more factor prices and move along AS so just see more inflation
in short run we see some impact because it takes time for monetary expansions to increase factor prices and shift SRAS
what is the quantity theory of money?
Changes in the nominal money supply lead to equivalent changes in the price level and wages
but do not have effects on output and employment
what is the formula for money market equilibrium
M/P = L ( Y, r)
M/P = money supply
L ( Y,r) = money demand
▶ M is nominal money
▶ P is the price level
▶ Y is real income
▶ r is the real interest rate
what equation can we use and what is it to demonstrate the link of what the quantity theory of money states?
equation of exchange
MV = PY
▶ M is nominal money
▶ V is the velocity of income
▶ P is the price level
▶ Y is potential real income
why would could using monetary policy be problematic?
▶ If nominal wages and prices adjust slowly, any increase in the nominal money supply will
result in a higher real money supply
▶ Excess real money supply will decrease interest rates which in turn will increase demand for
goods and services
▶ This additional demand will increase prices i.e. inflation
what is the objective of the bank of England with monetary policy?
▶ To deliver price stability
▶ To support the government’s economic policy
how is the price stability objective set
set by gov inflation target
but more recently has been more consistent with flexible inflation target
what are the pros and cons of central bank setting price stability objective with gov inflation target?
- Advantages
▶ Requires Central Bank to consider future path of inflation
▶ Provides focus on domestic objectives
▶ Inflation target involves an element of forward-looking - Disadvantages
▶ Lag between policy actions and market outcomes
▶ Can lead to large output fluctuations if adhered too rigidly
why is inflation expectations critical in evaluating monetary policy?
the credibility of inflation is important on success and ability as expected inflation impacts decision making
