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16 -- Part 2: The Dynamics of Inflation
The unemployment rate fell below the natural rate as inflation rose.
Unemployment exceeded the natural rate of inflation.
The natural rate of unemployment is assumed to be 5 percent of the labor force.
Inflation will increase if unemployment falls below this constant rate.
Inflation will fall if the unemployment is over 5 percent.
The natural rate of unemployment can change over time.
The rate of unemploy ment in the United States was thought to be between 6 and 7 percent at the beginning of the 1980s.
The natural rate of unemployment had fallen to about 5 percent by the late 1990s, according to many economists.
The natural rate can be decreased by the composition of the workforce.
Teenagers have higher unemployment rates than adults.
The natural rate of unemployment would decrease if the percentage of teenagers in the labor force decreased.
The share of teenagers in the labor force fell in the 1990s.
The natural rate of unemployment in the United States fell because of the change in demo graphics.
Laws, regulations, and economic institutions can affect the natural rate of unemployment.
The government might not be able to give unemployment benefits for a long time.
The natural rate of unemployment would fall if the unemployed returned to work more quickly.
The rise of temporary employment agencies in the United States made the labor market more efficient, according to some economists.
The decline of the natural rate was caused by workers being matched more quickly with jobs.
Generous benefits for the unem ployed increased the time they spent unemployed in Europe.
Restrictions on employers making it difficult to fire workers led them to hire fewer people.
The natural rate of employment was raised by these factors.
Some economists think the economic performance of the economy may affect the rate of unemploy ment.
The economy will go into a recession.
Many young people will fail to develop a strong work ethic during that time because they won't be able to find jobs.
Some workers may lose their skills during a long period of unemployment.
The natural rate of unemployment could increase due to both factors.
Wages must rise more slowly because they are tied to productivity increases in the long run if the growth rate in labor productivity falls.
If workers don't realize this, they might push for higher nominal wage increases and be less inclined to accept lower nominal wages.
The natural rate of unemployment will increase.
Firms will be willing to pay more to retain their workers if productivity growth is higher than anticipated.
Workers may not be as aggressive in asking for wage increases because they are happy with what they are getting.
The natural rate of unemployment will be lowered because they will be more inclined to accept these wages.
The natural rate of unemployment temporarily fell in the late 1990s when productivity growth soared, according to some economists.
There were no visible signs of inflation as unemployment fell to 4%.
The natural rate will return to its original value, closer to 5 percent, once workers in the economy understand that a shift in productivity growth has occurred.
A number of economists associated with the regional Federal Reserve banks have developed methods to estimate the natural rate of interest.
John Williams is the president of the Federal Reserve Bank of San Francisco.
In the last few years, the natural rate of interest has fallen from 3 to 2 percent.
The natural rate of on longer-term securities does not rise above 2 percent.
After temporary demand and supply shocks have subsided, the natural rate of interest is the same as full employment.
If the Fed was able to keep the real interest rate at the natural rate, the economy of San Francisco would be able to maintain itself at full strength.
The rate of interest can shift due to a website.
Monetary policymakers can influence expectations of inflation and actual behavior of workers and firms.
Workers will push for higher nominal wages when they anticipate inflation.
Firms will set their prices according to inflation.
It can be difficult for a society to fight inflation if policymakers are not careful in how they respond to expectations of inflation.
Consider an example.
Wages are being negotiated for workers in the auto and steel industries.
Other unions will likely follow if the union negotiates a high nominal wage.
The Fed will begin to see higher inflation as a result of the rising prices of autos and steel.
The Fed has kept the money supply constant.
The economy will fall into a recession.
The economy will be kept at full employment but prices will go up.
The actions of the union will be dependent on what the Fed does.
On the other hand, if they think the Fed won't increase demand, their actions will cause a recession.
The economy will remain at full employment and there will be no increase in prices if they don't negotiate an increase in nominal wages.
If union leaders believe the Fed will increase aggregate demand, they have nothing to lose and will push for higher nominal wages.
There will be higher prices in the economy.
Expectations about the Fed's determination to fight inflation will affect private sector behavior.
The private sector can be deterred from taking aggressive actions that drive up prices if the Fed is credible in its desire to fight inflation.
The heads of central banks prefer to risk increasing unemployment rather than inflation.
A conservative chair of the Fed will send a signal to everyone in the economy that the Fed will not increase money supply regardless of what happens in the private sector.
New Zealand took a different approach to ensure its central bank's credibility after experiencing high average inflation from 1955 to 1988.
The central bank has been operating under a law since 1989 that requires it to keep inflation under 2 percent a year.
The policy limits the central bank's ability to stable real GDP, but it also signals to the private sector that the central bank won't be increasing money supply.
Our example shows that with a credible central bank, a country can have lower inflation.
Some political scientists believe that central banks that are less subject to political influence will be more credible in their commitment to fighting inflation.
There is evidence that supports this hypothesis.
More independence is associated with lower inflation.
Germany had the highest index of central bank inde pendence and the lowest inflation rate.
The changes that occurred in the United Kingdom in the late 1990s show that credible banks can lower inflation safely.
On average, countries with central banks that are more independent from the rest of the government have lower inflation rates.
The country would no longer depend on the central bank to finance its debt.
Private parties valued the debt based on the ability of the government to meet interest and taxes.
There was an end to the hyperinflations and an increase in the demand for money in real terms by the private sector after the governments made these reforms.
Fiscal policy that was financed by money creation and not taxes was the cause of hyperinflation.
Once fiscal reforms were made, he suggested that inflation could be brought under control.
Most economists agree with the views of Sargent that moderate inflation can be ended by changing fiscal regimes and not enduring a recession.
The exercises are related.
The central bank's influence on expectations is important for understanding the behavior of prices and output in an economy.
Understanding how inflation expectations are formed in the private sector is important.
The theory of rational expectations has been used by economists to explain the credibility of central banks.
The theory of rational expectations suggests the union will anticipate whether the Fed will expand the money supply in the face of wage increases.
Wage increases can be deterred by not expanding the money supply.
Greenspan was determined to fight inflation.
During the 1990s, this helped reduce inflation.
Greenspan was expected to refuse to set out the "punch bowl" of money, and they were correct.
He or she does in the United States and other countries.
We mentioned in the beginning of the story that the U.S. government now sells bonds that protect investors from inflation.
TIPS can be used to protect investors from inflation.
Inflation rates can be stunning in countries.
Money turns over at a rate during the year.
The nominal GDP velocity of money is divided by the money supply.
One useful way to think of velocity is that it is the number of times money must change hands, or turn over, in economic transactions during a given year for an economy to reach its GDP level.
Consider a simple example.
The money supply is $1 trillion and the nominal GDP is $5 trillion.
Five times a year, the $1 trillion money supply has to change hands, in order to purchase the $5 trillion of nominal GDP.
If the money supply turns over five times in a year, people are holding each dollar of money for a year.
People don't hold money for a long time if it's very high because they turn it over quickly.
People hold onto money if it is low.
Money, velocity, and real GDP are linked in the equation.
Total nominal spending is also represented by it.
The quantity equation links money supply and GDP.
Money can be used to predict nominal GDP.
It's not easy, the velocity of money varies over time.
The low of 1.6 in the 1960s and the high of 2.1 in the late 1990s were the lows of this period.
Between 1.6 and 2.1 times a year, the total amount of M2 held by the public is turned over to the U.S. economy.
A constant equation links the growth rates of 3 percent a year and the velocity has zero growth.
It will be 7 percent a year.
The formula allows for both economic and velocity growth.
If velocity grew at 1 percent a year instead of zero, the annual inflation rate would be 8 percent.
This formula is used by economists to give quick estimates of the infla tion rate.
There is a link between the growth of money and the rate of inflation.
Money growth was the lowest in the 1950s.
Money growth was highest in the 1970s.
The link is not perfect because GDP and velocity grew at different rates.
Studies have shown that increases in money growth will lead to inflation.
Money growth is very high when inflation is high.
Understand the causes and origins of hyperinflation.
Selected data from his study is presented when the inflation rate is over 50 percent.
Greece, Hungary, and Russia have experienced hyperinfla tion.
For a period of 1 year, Greece had a monthly inflation rate of over 400 percent.
The price level increases by a factor of 4.55 each month.
Imagine if we had inflation of this magnitude in the United States.
$1 can buy a large order of french fries.
By the end of the month it would take $4.75 to buy the same order of french fries, and $1 would be worth only 21.5 cents.
The dollar would be worth only 4.5 cents after 2 months.
This inflation will continue month after month.
Money doesn't hold its value very long in hyperinflation.
After World War II, prices in Hungary increased by 19,800 percent a month.
In the early 1920s, prices in Russia rose by only 57 percent a month.
Hyperinflations have occurred in the past.
In the 1980s, there were three hyperinflations in Argentina, Bolivia and Nicaragua, all of which averaged 100 percent per month.
Money growth is believed to have caused the hyperinflations.
This can be seen in the data.
In Greece, the monthly inflation was accompanied by money growth of 220 percent.
Money growth in Hungary was 12,200 percent, and the monthly inflation was 19,800 percent.
During hyperinflations, the value of money plummets and no longer serves as a good store of value.
We would expect people to try to spend their money quickly in these circumstances.
Money should increase in speed during hyperinfla tions.
The last column shows the increase in velocity during hyperinflation.
In Greece, the velocity increased by a factor of 14.
In Hungary, the rate of inflation increased by a factor of 333.
Money doesn't facilitate exchange during hyperinflation.
There is a lot of confusion about the true value of commodities because prices are changing so fast.
The same commodities may sell for vastly different prices in different stores.
The process of searching for bargains and the lowest prices is very costly in human terms.
People have less time to make goods and services.
A hyperinflation can cause a country to live very long.
Hyperinflation must be stopped before it destroys the economy.
The answer is in the way some governments finance their deficits.
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