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AP Economics

AP Economics. Mr. Bernstein Module 33: Types of Inflation, Disinflation and Deflation February 1 1, 2014. AP Economics Mr. Bernstein. The Classical Model of Money and Prices Change in nominal m oney supply (M) l eads to change in a ggregate price level (P) so real quantity

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AP Economics

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  1. AP Economics Mr. Bernstein Module 33: Types of Inflation, Disinflation and Deflation February 11, 2014

  2. AP EconomicsMr. Bernstein The Classical Model of Money and Prices • Change in nominal money supply (M) leads to change in aggregate price level (P) so real quantity of money (M/P) remains unch’d

  3. AP EconomicsMr. Bernstein The Classical Model of Money and Prices • Assumes adjustment is automatic and instantaneous • Holds true during periods of high inflation but not in times of slower inflation • So in countries with persistently high inflation, increase in M are quickly turned into changes in P (inflation) but in other countries, changes in M may actually boost real GDP in short run

  4. AP EconomicsMr. Bernstein The Inflation Tax • Independent Central Banks create fiat currency • Treasury issues debt (borrows money) to fund government operations • The Fed prints money to buy Treasury debt • The Fed turns over interest earned back to Tsy • So the Fed effectively pays off debt by printing money • Revenue generated by the right to print money is known as seignorage • When the printing of money leads to inflation, eroding the purchasing power of currency held, they are said to be imposing an inflation tax on holders of the currency • An inflation tax is implicit, not explicit

  5. AP EconomicsMr. Bernstein The Logic of Hyperinflation • Gov’t decides to print money and collect seignorage, to cover a budget deficit • The public, fearing erosion in purchasing power of currency, avoids inflation tax by reducing holdings of money • Gov’t responds by printing more money to collect targeted real seignorage to cover deficit • People respond by reducing holdings of money again • Result: An inflationary spiral

  6. AP EconomicsMr. Bernstein Moderate Inflation and Disinflation • Cost-push inflation results from an increase in the price of resources, ie an increase in the price of steel will increase the price of cars and many other items • Demand-pull inflation results from an increase in demand for goods and services • Usually coupled with expansionary monetary or fiscal policy • Politicians may use fiscal policy such as tax cuts or public works during election years, leaving the costs of inflation until after they win the election

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