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Inflation: "Inflation Is Always and Everywhere A Monetary Phenomenon"

The document discusses the monetarist view that inflation is always and everywhere a monetary phenomenon, as stated by Frederic Mishkin. It asserts that whenever a country experiences extremely high inflation over a sustained period, its money supply growth is also extremely high. The monetarist view is that continually rising money supply will lead to continually rising prices as aggregate demand increases in response to more money.

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Achmad Trianto
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138 views18 pages

Inflation: "Inflation Is Always and Everywhere A Monetary Phenomenon"

The document discusses the monetarist view that inflation is always and everywhere a monetary phenomenon, as stated by Frederic Mishkin. It asserts that whenever a country experiences extremely high inflation over a sustained period, its money supply growth is also extremely high. The monetarist view is that continually rising money supply will lead to continually rising prices as aggregate demand increases in response to more money.

Uploaded by

Achmad Trianto
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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INFLATION

“Inflation is always and everywhere


a monetary Phenomenon”

Frederic S Mishkin, 2003, The Economics of Money, Banking, and


Financial Market, Sixth Edition Update, Chapter XXVI
Basic Question

1. What is the meaning of inflation?


2. What causes inflation?
3. How does inflationary monetary policy
come about?
What is Inflation?
 Inflation occurs when the general level of prices is rising
 We calculate inflation by using price indexes
(Consumers Price Index)
 The rate of inflation is the percentage change in the price
level:

Price level Y t – Price level Y t-1


Inflation rate = x 100
Price level Y t-1
The Categories of Inflation
1. Low inflation :
Prices that rise slowly and predictably

2. Galloping Inflation:
Prices are rising 20-200 percent per year
money loses its value very quickly

3. Hyper-inflation:
Prices are rising a million or even
a trillion percent per year
Inflation as a goal of monetary policy

Price stability is increasingly viewed as the


most important goal for monetary policy,
because:
A rising price level (inflation) creates
uncertainty in the economy, and that may
hamper economic growth
Inflation also makes it hard to plan for the
future
Inflation may strain a country’s social fabric
Money and Inflation

Some Evidences:
“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”
(Mishkin, 2003)
Views of Inflation:

1. Monetarist View:
the rapid inflation must be driven by
high money supply growth

2. Keynesian View:
 High inflation cannot be driven by
fiscal policy a lone
 Supply side phenomena cannot be the
source of high inflation
Monetarist view: Response to Continually
Rising Money Supply
Aggregate
Price
Level, P
AS4 AS3 AS2 AS1

Ms↑  AD ↑
P4   Y n to
 Y’ un-n↓ 
P3  wages ↑ 
 AS↓ Y’ to
P2  Y  P1 to
 P2 ,etc
P1 

AD1 AD2 AD3 AD4

Yn Y’ Aggregate Output, Y
Keynesian View: Can Fiscal Policy by itself
produce inflation?
Aggregate
Price Level, P One shot increase in
AS2 government
AS1 expenditure leads to
only a temporary
P2  increase in the price
level, but not a
 continuing increase.
AD2
P1 
AD1

Yn Y1’ Aggregate Output, Y


Keynesian View: Can supply side phenomena by
themselves produce inflation?

Aggregate
Price Level, P A negative shock
AS2
(embargo, wage push)
leads price level will rise
 AS1 temporarily but inflation
P2 will not result

P1 

AD1

Y1’ Yn Aggregate Output, Y


Types of Inflation

1. Cost-push inflation; which occurs


because of negative supply shocks or a
push by workers to get higher wages
2. Demand-pull inflation; which results
when policymaker pursue policies that
shift the aggregate demand curve to the
right
Origin of Inflationary Monetary Policy

1. High Employment Targets:


The first goal most governments pursue that
often result in inflation is high employment
Two types of inflation can result from an
activist stabilization policy to promote high
employment are :
 Cost-push inflation

 Demand pull inflation

2. Budget Deficits
Cost Push Inflation: with an Activist Policy to promote
High employment

Aggregate
Price
Level, P
AS4 AS3 AS2 AS1

P4  4
3’

P3 2’  3

P2 1’  2
P1’ 
P1  1

AD1 AD2 AD3 AD4

Y’ Yn Aggregate Output, Y
What role does monetary policy play in a
cost push inflation?

A cost push inflation is a monetary phenomenon


because it can not occur without monetary
authorities pursuing an accommodating policy of
higher rate of money growth
Demand Pull Inflation: The consequence of
setting too low an unemployment rate

Aggregate
Price
Level, P AS4 AS3 AS2 AS1

P4 

P3 

P2 

P1 

AD1 AD2 AD3 AD4

Yn Y T Aggregate Output, Y
Budget deficits and Inflation
Government Budget Constraint:

DEF = G – T = ∆MB + ∆B

Where:
DEF : Gov. Budget Deficit
G : Government Spending
T : Tax revenue
∆MB : Change in the monetary base
∆B : Change in government bond held by the public
Cont.
 If the government deficit in financed by an
increase in bond holdings by the public,
there is no effect on the monetary base and
hence on the money supply .
But
 If the deficit is not financed by increased
bonds holdings by the public, the monetary
base and the money supply in increase
 A deficit can be source of a sustained
inflation only it is persistent rather than
temporary and if the government finances
it by creating money rather than by issuing
bonds to the publics
Interest rate and Government Budget Deficit

Price Bond, P Interest Rate, i


(P increase ↑) (i increase↓)
B S1 BS2

P1   i1

P2  i2

B D1 BDR

Quantity of Bonds, B

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