Scribd
Upload
320 views2 pages

The Cagan Model PDF

This document summarizes the key aspects of the Cagan model of hyperinflation: 1) The model shows that the price level (pt) depends on both the current money supply (mt) and the expected growth rate of money (μ), such that an increase in money growth leads to a decrease in real money balances and an increase in inflation. 2) If the money growth rate is held constant, a change in the current money supply leads to a one-for-one change in the price level in the same direction. 3) If the central bank wants to keep the price level constant while reducing the money growth rate, it must offset this by increasing the current money supply, though private

Uploaded by

Mauricio
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
320 views2 pages

The Cagan Model PDF

This document summarizes the key aspects of the Cagan model of hyperinflation: 1) The model shows that the price level (pt) depends on both the current money supply (mt) and the expected growth rate of money (μ), such that an increase in money growth leads to a decrease in real money balances and an increase in inflation. 2) If the money growth rate is held constant, a change in the current money supply leads to a one-for-one change in the price level in the same direction. 3) If the central bank wants to keep the price level constant while reducing the money growth rate, it must offset this by increasing the current money supply, though private

Uploaded by

Mauricio
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

Macroeconomics

Lecturer: Cristian Castrillón

The Cagan Model


In the Cagan model, if the money supply is expected to grow at some constant rate 𝜇 (so that
𝐸𝑚𝑡+𝑠 = 𝑚𝑡 + 𝑠𝜇) then equation
1 𝛾 𝛾 2 𝛾 3
𝑝𝑡 = ( ) [𝑚𝑡 + ( ) 𝐸𝑚𝑡+1 + ( ) 𝐸𝑚𝑡+2 + ( ) 𝐸𝑚𝑡+3 + ⋯ ]
1+𝛾 1+𝛾 1+𝛾 1+𝛾

can be shown to imply that 𝑝𝑡 = 𝑚𝑡 + 𝛾𝜇.


𝑟
(Hint: use this result ∑∞ 𝑘
𝑘=0 𝑘𝑟 = (1−𝑟)2 ).

a) Interpret this result.


One way to interpret this result is to rearrange to find:
𝑚𝑡 − 𝑝𝑡 = −𝛾𝜇
That is, real balances depend on the money growth rate. As the growth rate of money rises, real
balances fall. This makes sense in terms of the model in this chapter, since faster money growth
implies faster inflation, which makes it less desirable to hold money balances.
b) What happens to the price level 𝑝𝑡 when the money supply 𝑚𝑡 changes, holding the money
growth rate 𝜇 constant?
With unchanged growth in the money supply, the increase in the level of the money supply 𝑚𝑡
increases the price level 𝑝𝑡 one-for-one.
c) What happens to the price level 𝑝𝑡 when the money growth rate 𝜇 changes, holding the
current money supply 𝑚𝑡 constant?
With unchanged current money supply 𝑚𝑡 , a change in the growth rate of money 𝜇 changes the
price level in the same direction.
d) If a central bank is about to reduce the rate of money growth 𝜇 but wants to hold the price
level 𝑝𝑡 constant, what should it do with 𝑚𝑡 ? Can you see any practical problems that might
arise in following such a policy?
When the central bank reduces the rate of money growth 𝜇, the price level will immediately fall.
To offset this decline in the price level, the central bank can increase the current level of the money
supply 𝑚𝑡 , as we found in part (b). These answers assume that, at each point in time, private agents
expect the growth rate of money to remain unchanged. So the change in policy takes them by
surprise—but once it happens, it is completely credible. A practical problem is that the private
sector might not find it credible that an increase in the current money supply signals a decrease in
future money growth rates. In that case, they might expect future money supply rates to be
adjusted by the rise in current money supply rates, leading to incorrect future predictions.
Macroeconomics
Lecturer: Cristian Castrillón

e) How do your previous answers change in the special case where money demand does not
depend on the expected rate of inflation (so that 𝛾 = 0)?
If money demand does not depend on the expected rate of inflation, then the price level changes
only when the money supply itself changes. That is, changes in the growth rate of money 𝜇 do not
affect the price level. In part (d), the central bank can keep the current price level 𝑝𝑡 constant
simply by keeping the current money supply 𝑚𝑡 constant.

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy