ECON-1007EL Chapter Notes - Chapter 30: Disinflation, Demand Shock, Potential Output
22 May 2018
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Chapter 30: Inflation and Disinflation
Definitions
Inflation
A rise in the average level of all prices. Usually expressed as the annual
percentage change in the Consumer Price Index
Rational
Expectations
The theory that people understand how the economy works and learn quickly
from their mistakes, so that even though random mistakes may be made,
systematic and persistent errors are not.
Demand Inflation
Inflation arising from an inflationary output gap caused, in turn, by positive AD
shock
Supply Inflation
Inflation arising from negative AS shock that is not the result of excess demand in
the domestic markets for factors of production.
Acceleration
Hypothesis
The hypothesis that when real GDP is held above potential, the persistent
inflationary gap will cause inflation to accelerate.
Expectations-
Augmented Phillips
Curve
The relationship between unemployment and the rate of increase of nominal
wages that arises when the output gap and expectations components of inflation
are combined.
Disinflation
A reduction in the rate of inflation
Stagflation
The simultaneous increase in inflation and reduction in output (or its growth rate)
that is caused by an upward shift of the AS curve.
Sacrifice Ratio
The cumulative loss in real GDP, expressed as a percent of potential output,
divided by the percentage-point reduction in the rate of inflation
Equations
Key Points
• The expectation of some specific inflation rate creates pressure for nominal wages to rise
by that rate.
• The net effect of the two macro forces acting on wages – output gaps and inflation
expectations – determines what happens to the AS curve.
• If inflation and monetary policy have been constant for several years, the expected rate of
inflation will tend to equal the actual rate of inflation.
• In the absence of supply shocks, if expected inflation equals actual inflation, real GDP
must be equal to potential GDP.
• Constant inflation with Y=Y* occurs when the rate of monetary growth, the rate of wage
increase, and the expected rate of inflation are all consistent with the actual inflation
• Continued validation of a demand shock turns what would have been transitory inflation
into sustained inflation fuelled by monetary expansion.
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Document Summary
A rise in the average level of all prices. Usually expressed as the annual percentage change in the consumer price index. The theory that people understand how the economy works and learn quickly from their mistakes, so that even though random mistakes may be made, systematic and persistent errors are not. Inflation arising from an inflationary output gap caused, in turn, by positive ad shock. Inflation arising from negative as shock that is not the result of excess demand in the domestic markets for factors of production. The hypothesis that when real gdp is held above potential, the persistent inflationary gap will cause inflation to accelerate. The relationship between unemployment and the rate of increase of nominal wages that arises when the output gap and expectations components of inflation are combined. The simultaneous increase in inflation and reduction in output (or its growth rate) that is caused by an upward shift of the as curve.
