Inflation & Business Cycles

Inflation Cycles:

In the long run, inflation occurs if the quantity of money grows faster than the real GDP

In the short run, many factors can start an inflation cycle:

• Demand Pull Inflation

• Cost Push Inflation

Demand Pull Inflation:

Inflation that starts because aggregate demand increases, before production can respond-increases, is called demand pull inflation. Demand pull inflation can begin with any factor that increases aggregate demand.

• An interest rate cut

• An increase in the quantity of money

• An increase in government expenditure

• A tax cut

• An increase in exports

Cost Inflation:

Inflation starts with an increase in cost is called cost push inflation. The main source of cost push inflation is a rise in the price of a factor of production.

• An increase in the money way rate

• An increase in the process of raw materials, i.e oil

Forecasting Inflation:

People’s expectation about future inflation influences their plans about consumption, savings, investment, production, employment and entrepreneurship. If the forecast include the best information available they are rational expectations. When expectations about inflation are correct, the economy is more likely to be at Potential GDP.

Business Cycles:

Business Cycles are fluctuations in economic activity that an economy experiences over time. A business cycle is characterized by expansion, where the economy experiences growth, and contraction, where the economy declines.

Organic Theories:

• Mainstream Business Cycle Theory

• Real Business Cycle Theory

Intervention Theories:

• Austrian Business Cycle Theory

Mainstream Business Cycle Theory:

Potential GDP grows at a steady pace while aggregate demand grows at a fluctuating rate, real GDP fluctuates around potential GDP. The fluctuations are random

Real Business Cycle Theory:

Real business cycle fluctuations in productivity are the main source of economic fluctuations. Productivity fluctuations mostly result from fluctuations in the pace of technological change. Other sources might be international disturbance, climate functions, or natural disasters.

When technological change is steady productivity grows at a moderate pace. But sometimes productivity growth speeds up and labor becomes more productive. A period of rapid productivity growth brings an expansion and a decrease in productivity growth creates a recession. A single theory that explains both growth and cycles.

Austrian Business Cycle:

The market as efficient. Fluctuations in prices, employment, output, and growth are normal reflections of th underlying economic data and adjustment process. Business cycles result from interventions to stabilize price, increase employment, create growth.

There is a structure of production

• Lower order, intermediate products, consumer, goods

Production takes place through time

• Goods are produced over many periods

• Capital is used to lengthens production process

• Greater capital investment allows higher output