Money and Banking Lecture 10 Money and Inflation

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Money and BankingLecture 10Money and Inflation

• Selcuk Caner
• Bilkent University

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Money and Inflation Evidence

• Inflation is always and everywhere a monetary
  phenomenon
• Whenever a countrys inflation rate is extremely
  high for a sustained period of time, its rate of
  money supply growth is also extremely high
• Reduced-form evidence

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Views of Inflation

• Money Growth
• Fiscal Policy
• Supply Shocks
• Always a monetary phenomenon

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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

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Origins of Inflationary Monetary Policy (contd)

• Two underlying reasons
• Adherence of policymakers to a high employment
  target
• Presence of persistent government budget deficits

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Activist/Nonactivist Policy Debate

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

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Activist/Nonactivist Policy Debate (contd)

• Nonactivists believe government should not get
  involved
• Activist accommodating policy produces volatility
  in both the price level and output

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Expectations and the Activist/Nonactivist Debate

• If expectations about policy matter the
  accommodating, activist policy with high
  employment targets may lead to inflation
• Nonactivist 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

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