Unit 5 Inflation, Exchange Rates and Modern Macro Chapter 32 Inflation, Disinflation and Deflation

I. Inflation Rising Prices Inflation Tax: A reduction in the value of money held by the public caused by inflation.

II. Hyperinflation Extreme, rapidly rising prices (100,000%) How does this occur? Gov. prints large amounts of money to cover a budget deficit. Public reduces money holdings Gov. must print more and more to make ends meet.

II. Moderate Inflation and Disinflation Cost-Push Inflation: caused by increase in prices of inputs important to economy Decreases AS curve Ex. OIL Demand-Pull Inflation: increase in aggregate demand. “too much money chasing too few goods”

Practice Use a correctly labeled aggregate supply and demand graph to illustrate cost-push inflation. Give an example of what might cause cost-push inflation in the economy besides oil prices.

III. The Phillips Curve Shows the tradeoff between inflation and unemployment. Discussion: What happens to inflation and unemployment when AD increases?

IV. The Long Run Phillips Curve Relationship between unemployment and inflation after expectations of inflation have adjusted. Disinflation: the process of bringing down inflation. Very costly, usually creates high levels of unemployment.

V. Liquidity Trap Interest rate is zero bound: cannot go below zero Liquidity trap: Monetary policy cannot be used anymore because interest rates are zero bound.

2011 FRQ Handout