Inflation
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Overview
► The
causes of inflation
► The effects of monetary injection
► The costs of inflation
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Inflation: Its Causes and Costs
► Inflation
is a sustained increase in the price
level. It is a continuous increase versus a
“once-and-for-all” increase in prices.
► Inflation deals with the increase in the
average of prices and not just significant
increases in the price of a few goods.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
The Causes of Inflation
is an economy-wide monetary
phenomenon that concerns, first and
foremost, the value of an economy’s
medium of exchange.
► To understand the cause of inflation as a
monetary phenomenon we must understand
the concepts of Money Supply, Money
Demand, and Monetary Equilibrium.
► Inflation
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Monetary policy
Definition
► Economic strategy chosen by a government
in deciding expansion or contraction in the
country's money-supply. Applied usually
through the central bank,
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Monetary Policy
Monetary policy employs three major tools:
1. Buying or selling national debt.
2. Changing credit restrictions.
3. Changing the interest rates by changing
reserve requirements.
Monetary policy plays the dominant role in control of the aggregatedemand and, by extension, of inflation in an economy.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
National Debt
Total outstanding borrowings of a central
government comprising of internal (owing to
national creditors) and external (owing to
foreign creditors) debt incurred in financing
its expenditure.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
National Debt
National debt plays a crucial role in a
country's financial system as government
securities (being a secure vehicle for
investment) form an important part of the
reserves of its financial institutions
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
National Debt
National debt is divided generally into three categories:
1. Floating debt, short term borrowings such as treasury
bills, various ways-and-means advances, and borrowings
from the central bank.
2. Funded debt, short-term debt converted into long-term
debt.
3. Unfunded debt, national savings certificates, savings
bonds, premium bonds, and securities repayable in foreign
exchange (payment of which affects the country's balance
of payments).
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Reserve Requirements
Minimum amount of cash or cashequivalents (computed as a percentage of
deposits) that banks and other depository
institutions, are required by law to keep on
hand, and which may not be used for
lending or investing.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Reserve Requirements
1.
2.
Reserve requirements serve as :
Safeguard against a sudden and inordinate
demand for withdrawals (as in a run on a
bank).
Control mechanism for injecting cash
(liquidity) into, or withdrawing it from, an
economy.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Money Supply and Money Demand
► Money
Supply is a variable of the Reserve
Bank of a country. Through instruments
such as open market operations, the RB
directly controls the quantity of money
supplied.
► Money Demand has several determinants
including:
 interest rates
 average level of prices in the economy
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Money Supply and Money Demand
► People
hold money because it is the
medium of exchange. The amount of
money people choose to hold depends on
the prices of the goods and services.
► In the long-run, the overall level of prices
adjusts to the level at which the demand for
money equals the supply.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Hyperinflation & Inflation Tax
► Hyperinflation
is inflation that exceeds 50
percent per month.
► Hyperinflation in some countries is caused
because the government prints too much
money to pay for their spending.
► Zimbabwe’s
inflation rate went up to 3,731.9% !
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Hyperinflation & Inflation Tax
► When
the government raises revenue by
printing money, it is said to levy an inflation
tax. An inflation tax is like a tax on everyone
who holds money.
► The inflation ends when the government
institutes fiscal reforms such as cuts in
government spending.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Types of inflation
►Demand
–Pull Inflation
►Cost Push inflation
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Cost – push inflation
Sustained increase in price of goods and
services, caused by the passing off
increased production costs to the consumers
by the producers. Also called cost inflation,
it is the opposite of demand-pull inflation.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition
Demand – Pull Inflation
Sustained increase in the prices of goods
and services resulting from a high demand,
stimulated by easy credit and hire purchase
offers accompanied by insufficient supplies.
In general, more inflation is caused by
demand-pull factors than by cost-push
factors. Also called demand inflation, it is
the opposite of cost-push inflation.
Department : Business Studies
Principles of Macroeconomics: Ch. 16
Second Canadian Edition