Monday 928

 

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 10 Money and Prices in the Long Run

Chapter 29 of 36 Money Growth and Inflation

Section 2 of 29

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Most prices rise over time, this increase in the level of prices is called inflation.

We have seen how economists measure the inflation rate as the percentage change in the consumer price index (CPI) and other indexes.

These price indexes show over the past 70 years prices have risen an average of about 4% per year.

Over 70 years, a 4% annual inflation rate results in a sixteen times increase in the price level.

On average something that cost one dollar 70 years ago costs $16 now.

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Inflation may seem natural and inevitable, but it is not.

There were periods in the 19th century when most prices fell, an occurrence called deflation.

The average price level in the U.S. economy was 23% lower in 1896 than in 1880.

Deflation was a major issue in the presidential election of 1896.

Farmers with large debts suffered.

The fall in crop prices reduced their incomes and their ability to pay their debts.

Deflation meant loans had to be paid back with more valuable dollars, e.g. a loan of $100 had to be paid back with deflated $100 nominal dollars = $105 real dollars.

With deflation banks could make money on zero interest loans.

Farmers advocated government policies to stop and reverse the deflation.

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In recent history there has been much variation in the U.S. inflation rate.

In the 1990s, prices rose an average of 2% per year.

In the 1970s, prices rose an average of 7% per year

A 7% per year rate doubles the price level over a decade.

Internationally, there is an even broader range of inflation experiences.

In 2007, while the U.S. inflation rate was about 4%, inflation was

· 0.7% in Japan

· 13% in Russia

· 25% in Venezuela

In February 2008, the central bank of Zimbabwe announced its economy’s annual inflation rate was 24,000%.

An extraordinarily high rate of inflation is called hyperinflation.

The Federal Reserve Bank targets a 2% inflation rate, below this there is risk of falling into deflation, above this is excessive inflation.

A 2% per year inflation rate doubles the price level over 35 years.

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extraordinarily high rate of inflation

hijō ni takai infure-ritsu

非常に高いインフレ率

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Why does the Fed increase interest rates when the economy starts to boom?

ChatGPT:

When the economy starts to grow rapidly, consumer spending and business investment may increase faster than the economy can produce goods and services, causing inflation.

The Fed may raise interest rates to make borrowing more expensive, encouraging consumers and businesses to reduce spending and investment.

This slows economic growth, reduces upward pressure on prices, and helps prevent the economy from becoming overly inflationary.

he Fed does not automatically raise rates whenever the economy grows rapidly—it mainly responds when strong demand threatens price stability.

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The Fed looks for several warning signs strong demand is creating inflationary pressure, including:

-rising consumer prices

-unusually rapid wage growth

-low unemployment

-labor shortages

-businesses raising prices because demand exceeds their ability to supply goods and services

It also monitors inflation expectations and measures such as the Personal Consumption Expenditures (PCE) price index.

If these indicators suggest inflation is likely to remain above the Fed's 2% target, it may raise interest rates to slow spending and borrowing.

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If an economy suddenly starts growing at a faster rate does it necessarily mean there is an inflation threat? CGPT:

No. Faster economic growth does not necessarily threaten price stability.

It depends on what causes the growth.

If growth results from higher productivity, new technology, or increased production capacity, the economy can produce more goods and services without generating significant inflation.

However, if growth results from rapidly increasing consumer, business, and government spending that exceeds the economy's ability to produce, inflation may accelerate.

The Fed therefore tries to distinguish between growth driven by increased production and growth driven by excessive demand.

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What reasons did the Fed give for the recent increase in interest rates? CGPT:

The Fed's September 16, 2026 interest-rate increase was primarily intended to combat persistent inflation.

It raised its target rate by 0.25 percentage point to 3.75%–4.00%, explaining inflation remained elevated while consumer spending, business investment, and employment were relatively strong.

The Fed believed the economy could withstand higher borrowing costs and raising rates would help bring inflation back toward its 2% target.

The Fed also faced inflationary pressures associated with higher energy prices and tariffs.

Its concern was not simply rapid economic growth, but inflation might remain high rather than decline on its own.