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33 Cards in this Set

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  • Back
inflation
a continuous rise in the price level
rational expectations
the expectations that economists' model predicts
adaptive expectations
expectations based in some way on the past
extrapolative expectations
expectations that a trend will continue
inflation
= nominal wage increase - productivity growth
(if wages and productivity both go up 2%, there's no inflationary pressure)
deflation
a sustained fall in the price level
real interest rate (in deflation)
= nominal interest rate + deflation
(nominal interest rate will not drop below 0 during deflation because ppl hold onto $ instead of bond, therefore, central bank cannot lower real interest rate to stimulate economy)
2 theories of inflation
1. quantity theory
2. institutional theory
quantity theory
the theory of inflation that emphasizes the connection between money and inflation
(money supply increases, price level increases;
demand-pull; Classical)
MV -> PQ
(focuses on the real economy, i.e. supply-side;
primary concerned with long run)
institutional theory
the theory of inflation that emphasizes market structure and price-setting institutions and inflation
(price increases, govt prints more $;
cost-push; Keynesian)
MV <- PQ
MV = PQ
equation of exchange: an equation stating that the quantity of money times velocity of money equals the price level times the quantity of real goods sold
(this is straightly a quantity theory thing)
M
Quatity of money
V
Velocity of money
(# of times per year, on average, a dollar goes around to generate a dollar's worth of income, OR amount of income per year generated by a dollar of money)
P
Price level
Q
quantity of real goods sold (real output of the economy/real GDP)
PQ
economy's nominal output (nominal GDP)
2 assumptions of the quantity theory
1. velocity is constant
(money is spent only so fast; and how fast is determined by the economy's institutional structure. This structure changes slwoly, therefore, velocity won't fluctuate very much)
2. real output (Q) is independent of the money supply (autonomous)
quantity theory of money
MV -> PQ
(assuming that V and Q are constant, price level varies in response to changes in the quantity of money)
Also, %changeM -> %changeP
inflation tax
an implicit tax on the holders of cash and the holders of any obligations specified in nominal terms (reduces the value of cash and other nominal obligations)
monetary regimes/feedback rules
hard and fast rules
(i.e. $ supply will be contracted by 1%, or the interest rate will be raised by 1.5 percentage points) when inflation rises by 3%, and the $ supply will be expanded by 1% when real output increases but remains below potential output.
monetary regimes/feedback rules takes monetary policy out of the hands of the politicians)
policy implications of institutional theory
institutional theorists suggest that contractionary monetary policies be used in combinatino with additional policies that directly slow down ifnlation at its source, i.e. income policy
income policy
a policy that places direct preesure on individuals to hold down their nominal wages and prices
demand-pull pressure
when the majority of industries are at close to capacity and they experience increases in demand
demand-pull inflation
inflation that occurs when the economy is at or above potential output;
generally characterized by shortages of goods and labors (firms can raise $ and still sell goods and labors can raise $ and still have work)
cost-pull pressure
price rises not related to demand pressure
cost-pull inflation
infaltion that occurs when the economy is below potential output
(when significant proportions of the markets or 1 v impt market experience $ rise not related to demand pressure, i.e. oil)
short-run Phillips curve
a downward-sloping curve showing the relationship bewteen inflation and unemployment when expectations of inflation are constant
(unemployment on x-axis, unemployment on y; high inflation, low unemployment; low inflation, high unemployment) (expectation of inflation are fixed, thus can differ from actual inflation)
stagflation
the combination of high and accelerating inflation and high unemployment
long-run Phillips curve
a vertical curve at the unemployment rate consistent with potential output
(expectations of inflation are equal to actual inflation on the long-run curve)
Republicans
often advised by supporters of the quantity theory generally favored contractionary monetary and fiscal policy (high unemployment, low inflation)
Democrats
often advised by supporters of the institutionary theory, generally favored expansionary monetary and fiscal policies (low unemployment, high inflation)
economy on left of long-run Phillips curve
- unemployment below target rate
- upward pressure on prices
economy on right of long-run curve
- unemployment above target rate
- downward pressure on prices