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Macroeconomic Analysis 2003. Theories of Inflation Blanchard (23) Mankiw (13). Learning Objectives. Inflation in the classical model Deficit financing and inflation Cagan’s model of hyper inflation Policies to control hyper inflation Demand pull and cost push inflations

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Macroeconomic Analysis 2003

Theories of Inflation

Blanchard (23) Mankiw (13)

Lecture 21


Learning objectives l.jpg
Learning Objectives

  • Inflation in the classical model

  • Deficit financing and inflation

  • Cagan’s model of hyper inflation

  • Policies to control hyper inflation

  • Demand pull and cost push inflations

  • Views on the role of economic policy

Lecture 21






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Determination of the Natural Rate of Unemployment: Wage and Price Setting and Inflation Example from Blanchard (2002; pp.179)

Lecture 21


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Policies used to control Hyperinflation Price Setting and Inflation Example from Blanchard (2002; pp.179)

Lecture 21


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Price and Output Response to Aggregate Demand Shock Price Setting and Inflation Example from Blanchard (2002; pp.179)

Y = Yn :Classical supply

AS

Neoclassical supply

c

P1

b

Keynesian Supply

a

d

P

Y = AD

AD1

LAS

AD0

0

Reply to a demand shock

Adaptive Expectation: a to b to c

Rational expectation: a to c

Keynesian response a to d

Y1

Y = yn

Lecture 21


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Aggregate Demand, Productive Capacity and the Price Level Price Setting and Inflation Example from Blanchard (2002; pp.179)

Higher Wage Rate Translates into Higher Prices

New Classical

AS

Price Level

P5

P4

c

AD3

b

Keynesian

P3

AD2

P1

a

New Keynesian part

AD1

AD4

AD0

Y3

Yc

Y0

Y1

Output Gap

Lecture 21


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Inflation, Output and Unemployment in the Short Run Price Setting and Inflation Example from Blanchard (2002; pp.179)

LAS

AS=f(w,pe)

AD =f(M,G, T)

o

Lecture 21


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Wage Price Spiral Aggregate Supply and Inflation Price Setting and Inflation Example from Blanchard (2002; pp.179)

Lecture 21


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U.K Retail price index 1271 - 1939 Price Setting and Inflation Example from Blanchard (2002; pp.179)(in long scale)

Prices increased around sevenfold over 650 years (with 200 years of stability) from Mitchell (1988) as in Miles and Scott Figure 12.1

Lecture 21


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Similar story in the United States Price Setting and Inflation Example from Blanchard (2002; pp.179)

Lecture 21


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World inflation, 1973-2000 Price Setting and Inflation Example from Blanchard (2002; pp.179)% increase in consumer prices

Inflation reveals a common international pattern

Lecture 21


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Adaptive and Rational Expectation Views on the Demand Pull Inflation

LAS

SAS

c

P2

b

P1

P

a

P0

AD1

AD0

0

Yn

Reply to a demand shock

Adaptive Expectation: a to b to c

Rational expectation: a to c

Y

Lecture 21


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Demand pull and Cost Push Inflation: Inflation

Movement of Aggregate Demand and Supply Around the Natural Rate

SA3

AS1

AS2

P2

d

e

AS0

P3

Price Level

c

P1

f

b

P0

AD3

AD1

a

AD0

0

YL

Yn

YH

Lecture 21


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Should Policy be Active or Passive? InflationClassical Economists on Economic Policy

Lecture 21


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Lags in Economic Policy Inflation

Lecture 21



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