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Chapter 28: Problem 8

An article in the Economist observed that "a sudden unanticipated spurt of inflation could lead to rapid economic growth." a. Briefly explain the reasoning behind this statement. b. Does it matter whether a spurt of inflation is unanticipated? Might different economists provide different answers to this question? Briefly explain.

Short Answer

Expert verified
The reasoning behind the statement is that unanticipated inflation can temporarily increase demand, which in turn may stimulate economic growth. Whether this inflation is 'unanticipated' may indeed affect the outcome, as different economic theories advance different views on how people formulate expectations and react to changes in here.

Step by step solution

01

Explain the connection between Inflation and Economic growth

Typically, a certain level of inflation is beneficial for economic growth as it encourages consumers to spend and invest, as opposed to holding cash. This subsequently drives demand for goods and services which, along with business investments, nurtures economic growth.
02

Address the impact of 'unanticipated' inflation

The 'unanticipated' aspect of inflation is key here. If people don't see the inflation coming, they may not adjust their consumption or investment decisions in time. This could create a temporary boost in demand, as prices are higher but people are still behaving as they were when prices were lower. This unexpected surge in demand might then spur economic growth.
03

Discuss differing economic perspectives

Different economists might indeed provide varying answers to the question. Economists who adhere to Rational Expectations theory may argue that people are fully informed and always act in a way that will maximize their value. Therefore, if inflation is unanticipated, it cannot influence economic growth. On the other hand, economists who believe in Adaptive Expectations might contend that people base their expectations on past experiences and may not anticipate the inflation, thus leading to a boost in economic growth.

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Most popular questions from this chapter

(Related to Solved Problem 28.4 on page 1011 ) Suppose the inflation rate has been 5 percent for the past four years. The unemployment rate is currently at the natural rate of unemployment of 4.5 percent. The Federal Reserve decides that it wants to permanently reduce the inflation rate to 3 percent. How can the Fed use monetary policy to achieve this objective? Be sure to use a Phillips curve graph in your answer.

In a blog post, former Fed Chairman Ben Bernanke argued that the Fed should not conduct monetary policy according to a rule, such as the Taylor rule, that it announces in advance. Among other objections, Bernanke noted that "the Taylor rule assumes that policymakers know, and can agree on, the size of the output gap. In fact ... measuring the output gap is very difficult and FOMC members typically have different judgments." (Note: In answering this problem, you may want to review the discussion of the Taylor rule in Chapter 26, Section 26.5.) a. Why is agreeing on the size of the output gap difficult? b. Why might disagreements over the size of the output gap make it difficult for the Fed to use a preannounced rule in conducting monetary policy?

An article in the Economist stated, "Robert Lucas ... showed how incorporating expectations into macroeconomic models muddled the framework economists prior to the 'rational expectations revolution' thought they saw so clearly." What economic framework did economists change as a result of Lucas's arguments? Do all economists agree with Lucas's main conclusions about whether monetary policy is effective? Briefly explain.

When Robert Shiller asked a sample of the general public what they thought caused inflation, the most frequent answer he received was "corporate greed." Do you agree that greed causes inflation? Briefly explain.

Why did Milton Friedman argue that the Phillips curve did not represent a permanent trade-off between unemployment and inflation? In your answer, be sure to explain what Friedman meant by the "natural rate of unemployment."
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