Chapter 24 Money and Inflation Money and Inflation

Chapter 24 Money and Inflation

Money and Inflation: Evidence • Inflation is always and everywhere a monetary phenomenon • Whenever a country’s inflation rate is extremely high for a sustained period of time, its rate of money supply growth is also extremely high • Reduced-form evidence Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 2

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Views of Inflation • Money Growth • Fiscal Policy • Supply Shocks • Always a monetary phenomenon Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 4

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Origins of Inflationary Monetary Policy • Cost-push inflation Cannot occur without monetary authorities pursuing an accommodating policy • Demand-pull inflation • Budget deficits Can be the source only if the deficit is persistent and is financed by creating money rather than by issuing bonds Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 8

Origins of Inflationary Monetary Policy (cont’d) • Two underlying reasons Adherence of policymakers to a high employment target Presence of persistent government budget deficits Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 9

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Activist/Nonactivist Policy Debate • Activists view self-correcting mechanism as slow • Policy lags slow activist policy Data lag Recognition lag Legislative lag Implementation lag Effectiveness lag Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 16

Activist/Nonactivist Policy Debate (cont’d) • Nonactivists believe government should not get involved Activist accommodating policy produces volatility in both the price level and output Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 17

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Expectations and the Activist/Nonactivist Debate • If expectations about policy matter the accommodating, activist policy with high employment targets may lead to inflation • Nonactivist policy may prevent inflation and discourage leftward shifts in short-run aggregate supply that lead to excessive unemployment Must be credible • Constant-money-growth-rate rule Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 19