AP Economics
Mr. Bernstein
Module 33:
Types of Inflation, Disinflation and
Deflation
January 2016
AP Economics
Mr. Bernstein
The Classical Model of Money and Prices
• Change in nominal
money supply (M)
leads to change in
aggregate price level
(P) so real quantity
of money (M/P)
remains unch’d
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AP Economics
Mr. Bernstein
The Classical Model of Money and Prices
• Assumes adjustment is automatic and
instantaneous
• Holds true during periods of high inflation but
not in times of slower inflation
• So in countries with persistently high inflation,
increase in M are quickly turned into changes in P
(inflation) but in other countries, changes in M
may actually boost real GDP in short run
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AP Economics
Mr. Bernstein
The Inflation Tax
• Independent Central Banks create fiat currency
• Treasury issues debt (borrows money) to fund government
operations
• The Fed prints money to buy Treasury debt
• The Fed turns over interest earned back to Tsy
• So the Fed effectively pays off debt by printing money
• Revenue generated by the right to print money is known as
seignorage
• When the printing of money leads to inflation, eroding the
purchasing power of currency held, they are said to be
imposing an inflation tax on holders of the currency
• An inflation tax is implicit, not explicit
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AP Economics
Mr. Bernstein
The Logic of Hyperinflation
• Gov’t decides to print money and collect seignorage,
to cover a budget deficit
• The public, fearing erosion in purchasing power of
currency, avoids inflation tax by reducing holdings of
money
• Gov’t responds by printing more money to collect
targeted real seignorage to cover deficit
• People respond by reducing holdings of money again
• Result: An inflationary spiral
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AP Economics
Mr. Bernstein
Moderate Inflation and Disinflation
• Cost-push inflation results from an increase in the
price of resources, ie an increase in the price of steel
will increase the price of cars and many other items
• Demand-pull inflation results from an increase in
demand for goods and services
• Usually coupled with expansionary monetary or fiscal
policy
• Politicians may use fiscal policy such as tax cuts or public
works during election years, leaving the costs of inflation
until after they win the election
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