ECON 2006 Lecture Notes - Lecture 16: Price Level, Seigniorage, Nominal Interest Rate
Document Summary
In the short run: an increase in the money supply increases real gdp by lowering the interest rate and stimulating investment spending and consumer spending. In the long run: as nominal wages and other sticky prices rise, real gdp falls back to its original level. So, in the long run, an increase in the money supply does not change real gdp. The logic of hyperinflation: to avoid paying the inflation tax, people reduce their real money holdings and force the government to increase inflation to capture the same amount of real inflation tax. In some cases, this leads to a vicious circle of a shrinking real money supply and a rising rate of inflation: this leads to hyperinflation and a fiscal crisis. Okun"s law: there is a predictable negative relationship between the output gap and the unemployment rate. Modern estimates find that a rise in the output gap of 1% reduces the unemployment rate by about 0. 5%
