DO NOW: INFLATION GROUP WORK , but everybody records answers on individual sheets! INFLATION ON COCO ISLE Terms: INFLATION: A rise in price level (TOOOOOO MUCH MONEY chasing TOOOOOO FEW GOODS!) DEFLATION: A drop below the initial price level DISINFLATION: A lowering in price level which does not drop below the original price
What is INFLATION? • A rise in price level that DECREASES the purchasing power of money
Who does it help or hurt? • Helps • DEBTORS • Borrow GOOD money and buy GOOD STUFF • Pay back BAD money • Hurts • CREDITORS • Loan out GOOD money and get paid back in BAD • INFLATION eats up INTEREST and EARNINGS • PEOPLE on FIXED INCOMES • Retirees on Social Security
2 KINDS OF INFLATION: • COST-PUSH INFLATION: prices rise because there is an increase in the cost of inputs (factors of production); supply shrinks in relation to demand, pushing EQUILIBRIUM PRICE UP! • DEMAND-PULL INFLATION: prices rise because there is an increase in demand (“gimmie-gimmie”); demand increases in relation to supply PUSHING EQUILIBRIUM PRICE UP!
MEASURING INFLATION: • CPI - CONSUMER PRICE INDEX: • a tool the government uses to measure INFLATION (the CHANGE IN PRICE of a market basket of goods and services used by average households OVER TIME!) • compiled monthly by the BLS – Bureau of Labor Statistics; they pick a BASE YEAR as 100 and compare current prices to base year prices; > 100 = INFLATION; <100=DEFLATION; most COMMON measure (See p. 339-40) • PPI- PRODUCER PRICE INDEX: tool that measures inflation on the SUPPLY SIDE • GDP DEFLATOR: a tool the government uses to measure INFLATION; more accurate, but less common
PROBLEMS & SOLUTIONS: • PROBLEM=INFLATION; solution = SUCK money out of the economy to slow things down (TIGHT MONEY POLICY – CONTRACTION!) • PROBLEM=UNEMPLOYMENT; solution = BLOW money into the economy to stimulate growth (LOOSE MONEY POLICY – EXPANSION!)
CONTROLLING THE MONEY SUPPLY • FISCAL POLICY: What the government can do (congress and the president) – DUSTBUSTER! • MONETARY POLICY: What the Federal Reserve can do – BIG VAC! (Ben Bernanke – CHAIRMAN OF THE FED – and his gang – THE FEDERAL RESERVE BD.)
Video Tutorial • EPISODE 26: Fiscal Policy (4:34)
FISCAL POLICY • TAX : raise or lower taxes --EXPANSIONARY POLICY (BLOW! to stimulate growth) cut taxes! LOOSE MONEY! --CONTRACTIONARY POLICY (SUCK! to fight inflation) raise taxes! TIGHT MONEY! • SPEND: increase or decrease spending --EXPANSIONARY POLICY (BLOW! to stimulate growth) increase spending! --CONTRACTIONARY POLICY (SUCK! to fight inflation) decrease spending
AUTOMATIC STABILIZERS & DISCRETIONARY POLICY • AUTOMATIC STABILIZERS: • Changes in spending which DO NOT require deliberate action from policy makers • Kick in when needed during an economic downturn • Example: UNEMPLOYMENT BENEFITS in a recession • DISCRETIONARY • Changes in spending that require the government to act • Corporate BAILOUT • New legislation on infrastructure projects like high speed rail, to create jobs
FISCAL STIMULUS HIGH MPC LOW MPS
Federal Budget: (See Solman video) • DEFICIT: • Total amount by which EXPENDITURES exceed REVENUES in a single year • SURPLUS: • Total amount by which REVENUES exceed EXPENDITURES in a single year • DEBT: • Total amount of money owed by the federal government, accumulated over the years
THE CROWDING OUT EFFECT • EPISODE 27: Crowding Out - Lags (5:51)
Video Tutorial • EPISODE 31: The Fed (2:30) • EPISODE 32: Monetary Policy (7:18)
What is the Federal Reserve? • The central banking system for the United States • Responsible for carrying on MONETARY POLICY • Created in 1913 by the Federal Reserve Act
MONETARY POLICY • RESERVE REQUIREMENT (raise or lower – just NOT done!) • OPEN MARKET OPERATIONS (buy or sell federal government bonds) • INTEREST RATE (raise or lower the DISCOUNT RATE or FEDERAL FUNDS RATE) --DISCOUNT RATE: interest rate at which member banks borrow from the federal reserve --FEDERAL FUNDS RATE: interest rate at which banks borrow from each other
TWO TYPES OF POLICIES: • EXPANSIONARY POLICY (loose money policy) geared to stimulate growth and create jobs …………………...BLOW MONEY INTO THE ECONOMY! • CONTRACTIONARY POLICY (tight money policy) geared to slow growth and tame inflation) ……………………SUCK MONEY OUT OF THE ECONOMY!
The U.S. Economy Stagnated in the 1970s • President Lyndon B. Johnson’s spending on the Vietnam War and on his Great Society program also depleted the U.S. treasury • Also, since the U.S. did not continue advancing, they were caught by the Japanese and the Germans in industries that the U.S. once dominated: steel, automobiles, consumer electronics.
1973 OIL SHOCK Yom Kippur War
Video Tutorial • STAGFLATION: (30:00)
1. A rise in the price level which decreases the purchasing power of money is called • a. inflation • b. deflation • c. disinflation • d. hyperinflation • e. stagflation
2. A decline in the price level is called • a. hyperinflation • b. inflation • c. stagflation • d. disinflation • e. deflation
3. A decline in the rate of inflation is called • a. hyperinflation • b. disinflation • c. inflation • d. deflation • e. stagflation
4. Modern fiscal policy results from the work of • a. Jean Baptiste Say • b. Arthur Laffer • c. John Maynard Keynes • d. Arthur Okun • e. Thomas Malthus
5. Which policy measure would a Keynesian economist support to combat recession? • a. doing nothing • b. balanced budget • c. decreasing wages • d. deficit spending • e. printing money
6. What is an appropriate fiscal policy measure to combat recession? • a. decreasing the federal funds rate • b. increasing government spending • c. purchasing government securities • d. increasing the reserve ratio • e. There is no appropriate fiscal policy measure to combat recession.
7. What is an appropriate fiscal policy measure to combat inflation? • a. increasing government spending • b. increasing the discount rate • c. increasing the tax rate • d. increasing the federal funds rate • e. There is no appropriate fiscal policy measure to combat inflation.