The inflation rate is 10 percent, and the central bank is...

Name: Problem 5, Chapter 22: Principles of Macroeconomics
Uploaded: 2019-06-23T23:39:20-08:00
Duration: 4 min 43 s
Channel: Alex Loukas
Description: The inflation rate is 10 percent, and the central bank is considering slowing the rate of money growth to reduce inflation to 5 percent. Economist Milton believes that expectations of inflation change quickly in response to new policies, whereas economist James believes that expectations are very sluggish. Which economist is more likely to favor the proposed change in monetary policy? Why?

The inflation rate is 10 percent, and the central bank is considering slowing the rate of money growth to reduce inflation to 5 percent. Economist Milton believes that expectations of inflation change quickly in response to new policies, whereas economist James believes that expectations are very sluggish. Which economist is more likely to favor the proposed change in monetary policy? Why?

Key Concepts

Monetary Policy

Monetary policy refers to the actions taken by a central bank, such as adjusting the money supply growth rate, to influence macroeconomic factors like inflation, employment, and economic growth. In this context, a change in monetary policy is proposed to reduce inflation by slowing money growth, highlighting the central bank's role in managing the economy.

Inflation Expectations

Inflation expectations involve the beliefs held by economic agents—households, firms, and investors—about the future rate of inflation. These expectations play a critical role in shaping current economic behavior, such as pricing and wage setting, which in turn affect actual inflation. The speed at which expectations adjust to new monetary policies is crucial in determining how quickly a change in policy can impact inflation.

Transcript

00:01 In question five, we're being given that the inflation rate is 10%, and the central bank is considering slowing the rate of money growth to reduce inflation down to 5%.

00:13 Economist milton believes that expectations of inflation change quickly in response to new policies, whereas economist james believes that expectations are very sluggish.

00:25 Which economist is more likely to favor the proposed change in monetary policy? and why.

00:31 All right, first of all, i need to say that in order to answer this question, we do not need to draw a graph.

00:37 However, i think it makes our job way easier to have to, you know, to be able to visualize what's going on in this economy.

00:47 So i've drawn a very simple graph, as usual.

00:49 On the x -axis, we have the unemployment level u.

00:51 On the y -axis, we have inflation rate high.

00:54 The long -run phillips curve is vertical, dissect the x -axis at the natural level of unemployment u1.

01:00 And here you can see two short -run phillips curve.

01:02 Just disregard the second one for a moment.

01:06 And just concentrate on srpc1, which intersects the longer -upilips curve at point a, which is longer on equilibrium.

01:15 So this is where the economy starts from.

01:18 And we can see that we know that the point where the long -run and the short -in -filps curve intersect corresponds to the expectations for inflation from the consumers.

01:31 So we see that indeed here, the first short -in -films curve is consistent with the 10 % level of expected inflation.

01:40 Now, what the central bank is proposing to do is engage in contractionary monetary policy and move along the phillips curve in order to go from point a to point b, right? and once the actual inflation has fallen in a lot, then hopefully inflation expectations will adjust and the economy will move to a new shorter on phillips curve, srpc2...

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