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M24 - Mishkin599853 - 09 - C24 23

The document discusses the relationship between money supply and inflation, asserting that inflation is primarily a monetary phenomenon influenced by high money growth. It explores various factors contributing to inflation, including fiscal policy, supply shocks, and government budget deficits, ultimately concluding that persistent high inflation is driven by monetary policy. The text also touches on the debate between discretionary and nondiscretionary policy approaches in managing inflation.

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20 views19 pages

M24 - Mishkin599853 - 09 - C24 23

The document discusses the relationship between money supply and inflation, asserting that inflation is primarily a monetary phenomenon influenced by high money growth. It explores various factors contributing to inflation, including fiscal policy, supply shocks, and government budget deficits, ultimately concluding that persistent high inflation is driven by monetary policy. The text also touches on the debate between discretionary and nondiscretionary policy approaches in managing inflation.

Uploaded by

mrmaabs2
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
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Chapter 24

Money and
Inflation

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


Money and Inflation:
Evidence
• Inflation is always and everywhere a
monetary phenomenon
• 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
• Reduced-form evidence

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-2
FIGURE 1 Money Supply and Price
Level in the German Hyperinflation

Source: Frank D. Graham, Exchange, Prices and Production in Hyperinflation: Germany, 1920–25 (Princeton, NJ: Princeton
University Press, 1930), pp. 105–106.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-3
Views of Inflation

• Money Growth
– High money growth produces high inflation
• Fiscal Policy
– Persistent high inflation cannot be driven by fiscal
policy alone
• Supply Shocks
– Supply-side phenomena cannot be the source of
persistent high inflation
• Conclusion: always a monetary phenomenon

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-4
FIGURE 2 Response to a
Continually Growing Money Supply

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-5
FIGURE 3 Response to a One-Shot Permanent
Increase in Government Expenditure

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-6
FIGURE 4 Response to a Supply
Shock

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-7
Origins of Inflationary
Monetary Policy
• Cost-push inflation
– Cannot occur without monetary authorities
pursuing an accommodating policy
• Demand-pull inflation
• Budget deficits
– Can be the source only if the deficit is persistent
and is financed by creating money rather than by
issuing bonds

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-8
Origins of Inflationary
Monetary Policy (cont’d)
• Two underlying reasons
– Adherence of policymakers to a high employment
target
– Presence of persistent government budget
deficits

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-9
FIGURE 5 Cost-Push Inflation with an Activist
Policy to Promote High Employment

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-10
FIGURE 6 Demand-Pull Inflation: The Consequence of
Setting Too Low an Unemployment Target

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-11
FIGURE 7 Interest Rates and the
Government Budget Deficit

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-12
FIGURE 8 Inflation and Money
Growth, 1960–2008

Source: Economic Report of the President; www.federalreserve.gov/releases/h6/hist/h6hist1.txt.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-13
FIGURE 9 Government Debt-to-
GDP Ratio, 1960–2008

Source: Economic Report of the President.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-14
FIGURE 10 Unemployment and the Natural
Rate of Unemployment, 1960–2008

Sources: Economic Report of the President and Congressional Budget Office.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-15
The Discretionary/Nondiscretionary
Policy Debate

• Advocates of discretionary policy regard the


self-correcting mechanism as slow
• Policy lags slow activist policy
– Data lag
– Recognition lag
– Legislative lag
– Implementation lag
– Effectiveness lag

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-16
The Discretionary/Nondiscretionary
Policy Debate (cont’d)

• Advocates of nondiscretionary policy believe


government should not get involved
– Discretionary policy produces volatility in both
the price level and output

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-17
FIGURE 11 The Choice Between Discretionary
and Nondiscretionary Policy

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-18
Expectations and the
Discretionary/Nondiscretionary Debate

• If expectations about policy matter,


discretionary policy with high employment
targets may lead to inflation
• Nondiscretionary policy may prevent
inflation and discourage leftward shifts in
short-run aggregate supply that lead to
excessive unemployment
– Must be credible
• Constant-money-growth-rate rule

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.


24-19

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