Intermediate
Macroeconomics
Lecture 5
Inflation
Definition
Inflation,The overall increase in prices
Hyperinflation,extraordinary high
inflation
Real v.s,Nominal Interest
Rate
The Fisher equation
r,real interest rate
i,nominal interest rate
, inflation rate
Nominal interest rate can change because of
the change in the real interest rate or/and the
inflation rate
ir ???
?
Nominal Interest Rate
The quantity theory + the Fisher equation
An increase in the rate of money growth of 1% causes
a 1% increase in the rate of inflation; then a 1%
increase in the rate of inflation in turn causes a 1%
increase in the nominal interest rate
This one-for-one relation between the inflation rate and
the nominal interest rate is called the Fisher effect,
(one-for-one refers to %,not its value)
Ex Ante v.s,Ex Post
eir ???
If there is a rumor that the oil price will go up
further due to possible OPEC limitation of
production,what will happen?
Demand for Money
The cost of holding money
1) Do not earn interest
2) Pay the cost for possible inflation
So,the cost of holding money is
er ??
The Demand for Money
(,)
dM
L i YP?? ?????
(,)
d
eM L r Y
P ?
?? ????
??
How To Stop a Hyperinflation
If the quantity theory were completely
true
where
? i did not affect money demand
? stabilize money supple = stabilize P
dM
kYP?? ???
??
1 V
k ?
How To Stop a Hyperinflation
However,if the Fisher effect holds
is the cost for holding money
? stabilize money supply makes
? increases
? since M is stable,must be that p ↓
? deflation
(,)
d
eM L r Y
P ?
?? ????
??
er ??
e? ↓
dM
P
????
??
How To Stop a Hyperinflation
What is the path to get to the end of
hyperinflation without causing deflation?
P
?
i
M/P
M
0
r
Time End of inflation
The Social Costs of Inflation
Expected inflation
1,Shoeleather cost
2,Menu cost
3,Possible lower relative price
4,Tax liability
5,Confusion in value measuring
The Social Costs of Inflation
Unexpected inflation
1,Redistribute wealth among individual
2,Hurts individual on fixed pensions
3,More uncertainty (most people are
risk-averse)
Macroeconomics
Lecture 5
Inflation
Definition
Inflation,The overall increase in prices
Hyperinflation,extraordinary high
inflation
Real v.s,Nominal Interest
Rate
The Fisher equation
r,real interest rate
i,nominal interest rate
, inflation rate
Nominal interest rate can change because of
the change in the real interest rate or/and the
inflation rate
ir ???
?
Nominal Interest Rate
The quantity theory + the Fisher equation
An increase in the rate of money growth of 1% causes
a 1% increase in the rate of inflation; then a 1%
increase in the rate of inflation in turn causes a 1%
increase in the nominal interest rate
This one-for-one relation between the inflation rate and
the nominal interest rate is called the Fisher effect,
(one-for-one refers to %,not its value)
Ex Ante v.s,Ex Post
eir ???
If there is a rumor that the oil price will go up
further due to possible OPEC limitation of
production,what will happen?
Demand for Money
The cost of holding money
1) Do not earn interest
2) Pay the cost for possible inflation
So,the cost of holding money is
er ??
The Demand for Money
(,)
dM
L i YP?? ?????
(,)
d
eM L r Y
P ?
?? ????
??
How To Stop a Hyperinflation
If the quantity theory were completely
true
where
? i did not affect money demand
? stabilize money supple = stabilize P
dM
kYP?? ???
??
1 V
k ?
How To Stop a Hyperinflation
However,if the Fisher effect holds
is the cost for holding money
? stabilize money supply makes
? increases
? since M is stable,must be that p ↓
? deflation
(,)
d
eM L r Y
P ?
?? ????
??
er ??
e? ↓
dM
P
????
??
How To Stop a Hyperinflation
What is the path to get to the end of
hyperinflation without causing deflation?
P
?
i
M/P
M
0
r
Time End of inflation
The Social Costs of Inflation
Expected inflation
1,Shoeleather cost
2,Menu cost
3,Possible lower relative price
4,Tax liability
5,Confusion in value measuring
The Social Costs of Inflation
Unexpected inflation
1,Redistribute wealth among individual
2,Hurts individual on fixed pensions
3,More uncertainty (most people are
risk-averse)
