A

Vocabulary Flashcards for ECON 2120: Macroeconomics

Causes of Inflation

  • Main Causes: Increases in the money supply are the primary cause of inflation.
  • Additional Factors: Changes in the velocity of money and real GDP can also affect prices.
  • High Inflation: Velocity of money can increase, worsening inflation.
  • Economic Panic: Velocity can decrease, leading to disinflation or deflation.
  • Definitions:
  • Disinflation: A reduction in the inflation rate.
  • Deflation: A decrease in the average price level (negative inflation).

Exam-Type Questions

  • Identify the year experiencing deflation or disinflation based on provided data from 2013-2017.

Money Neutrality

  • Concept: Changes in the money supply do not change the real GDP in the long run (Money Neutrality).
  • Intuition:
  • Real GDP changes due to factors like capital, labor, technology, or productivity changes, not the quantity of money.
  • Increased money supply leads to inflation, making currency less valuable.

Evidence for Money Neutrality

  • Growth rates of real GDP and currency show that higher money supply does not correlate with higher GDP growth rates.

Long-Run Neutrality of Money

  • Reiteration: In the long run, changes in money supply do not affect real GDP.

Understanding Inflation

  • Topics Covered:
  1. Definition and Measurement of Inflation
  2. Inflation Trends (time and countries)
  3. Causes of Inflation
  4. Costs of Inflation

Costs of Inflation - Introduction

  • If wages and income rise with inflation, average real purchasing power can remain the same.
  • Problems arise when inflation is unpredictable, making it difficult for individuals to prepare.
  • Inflation disrupts the signaling function of market prices regarding resource value and opportunities.

Specific Costs of Inflation

  1. Price Confusion and Money Illusion:
  • Inflation complicates price signals, making it hard to determine demand vs. increased money supply.
  • Money Illusion: Confusing nominal price changes for real price changes, leading to misinterpretations (e.g., salary increases vs. real purchasing power).
  1. Redistribution of Wealth:
  • Unanticipated inflation can shift wealth from citizens to the government.
  • Inflation Tax: The loss of purchasing power due to inflation is akin to a tax.
  • Lender vs. Borrower Dynamics: Inflation impacts lenders negatively by reducing real returns on loans, benefitting borrowers.

Detailed Example of Wealth Redistribution

  • Loan scenario explaining how inflation affects repayments:
  • If Daniel agrees to repay $12 on a $10 loan at 20% interest, increased inflation decreases the real value of his repayment to Mary.
  • Conversely, if inflation decreases, the real value of what Daniel pays increases, benefiting Mary.

Rates of Return and Inflation Effects

  • Nominal Rate of Return (i): Does not account for inflation.
  • Real Rate of Return (rReal): Nominal return minus inflation rate (rReal = i - π).
  • Lender Behavior:
  • Lenders demand higher nominal interest rates when anticipating inflation.
  • Fisher Effect: Nominal interest rate rises with expected inflation rates; formula: i = E[π] + r_Eq.

Summary of Fisher Effect

  • Confirming that with increasing inflation, nominal interest rates also rise, illustrating the impact on economic behavior and lending practices.