Chapter 32 - Inflation. In this chapter you will learn: How to explain the neutrality of money? What the classical theory of inflation is? What relationship exists between the quantity theory of money and inflation (and deflation)?. | Chapter 32 Inflation © 2014 by McGraw-Hill Education 1 What will you learn in this chapter? • How to explain the neutrality of money. • What the classical theory of inflation is. • What relationship exists between the quantity theory of money and inflation (and deflation). • What the role of monetary policy is in creating inflation and deflation, and what their economic consequences are. • What relationship exists between inflation, the output gap, and monetary policy. • How the Phillips curve models the relationship between inflation and unemployment. © 2014 by McGraw-Hill Education 2 Changing price levels • The price level, and especially changes in it, is one of the most important concepts in macroeconomics. • Inflation is an overall rise in prices in the economy. • Deflation is an overall fall in prices in the economy. • Core inflation excludes goods with historically volatile price changes. • Headline inflation includes all of the goods that the average consumer buys. © 2014 by McGraw-Hill Education 3 1 Changing price levels To understand the underlying rate of inflation in the economy, headline inflation and core inflation are often differentiated. Percentage % 6 CPI Core CPI 5 4 3 2 1 0 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 -1 -2 • Core CPI represents core inflation. • Core CPI is much more stable than headline inflation. © 2014 by McGraw-Hill Education 4 The neutrality of money • A country’s GDP is simply an accounting of all of the purchases and sales that take place over a given period. • Measuring output in terms of money can be problematic. • The aggregate price level is a measure of the average price level for GDP. – Price indices, such as the CPI or GDP deflator, convert nominal values into real values. • The neutrality of money is the idea that real outcomes in the economy are not affected by aggregate price levels. © 2014 by McGraw-Hill Education 5 The classical theory of inflation • The classical theory of inflation .
