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Understanding Inflation Dynamics: Impacts & Strategies

Explore types of inflation, disinflation, and deflation in economics. Learn the classical model's effects on money supply and price levels. Understand the inflation tax, hyperinflation logic, and managing moderate inflation and disinflation.

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Understanding Inflation Dynamics: Impacts & Strategies

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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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