Types of Inflation, Disinflation, and Deflation Is Inflation Always a Bad Thing?

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Types of Inflation, Disinflation, and Deflation Is Inflation Always a Bad Thing?

E2E2 Increasing the Money Supply: Classical Model of the Price Level AD 2 AD 1 Aggregate Price Level Real GDP Y1Y1 Y2Y2 P1P1 P2P2 E1E1 LRAS Inflationary gap Potential output SRAS 2 SRAS 1 E3E3 P3P3 …and moves the economy back to potential output. If the government engages in expansionary monetary policy AD shifts to the right. An increase in the money supply reduces the interest rate and increases aggregate demand… …but the eventual rise in nominal wages leads to a fall in short-run aggregate supply… The Classical Model of the Price Level ignores the E 2 transition period and thinks of prices going to P 3 immediately. Classical Model of the Price Level

E2E2 Increasing the Money Supply: Classical Model of the Price Level AD 2 AD 1 Aggregate Price Level Real GDP Y1Y1 Y2Y2 P1P1 P2P2 E1E1 LRAS Inflationary gap Potential output SRAS 2 SRAS 1 E3E3 P3P3 …and moves the economy back to potential output. If the government engages in expansionary monetary policy AD shifts to the right. An increase in the money supply reduces the interest rate and increases aggregate demand… …but the eventual rise in nominal wages leads to a fall in short-run aggregate supply… The Classical Model of the Price Level ignores the E 2 transition period and thinks of prices going to P 3 immediately. Classical Model of the Price Level

Questions 1. When would the Classical Model of the Price Level be a good model of economic conditions? When would it not?