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1、19-119-2Chapter19Big Events: The Economics of Depression, Hyperinflation,and DeficitsItem ItemItemEtc.McGraw-Hill/IrwinMacroeconomics, 10e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.19-3IntroductionGreat events shape both the economy and the study of economicsThe study of macroeconomi

2、cs in particular grows out of economic experiences especially traumatic onesIn the Great Depression 25% of the labor force was unemployedDuring the 20th century many countries experienced hyperinflationOver the later part of the 20th century the budget balance in the U.S. swung from deficit to surpl

3、us, and then back to deficitLooking to the future, will the U.S. social security system remain solvent, or will it crash in the 21st century?In this chapter we examine these issues and their influence on economic theory.19-4The Great Depression: The FactsThe Great Depression shaped many institutions

4、 in the economy, including the Federal Reserve and modern macroeconomicsThe essential facts about the Depression are shown in Table 19-1During the Great Depression:The stock market fell by 85%GNP fell by 30%The unemployment rate rose from 3 to 25%Net investment was negativeCPI fell nearly 25%Insert

5、Table 19-1 here19-5The Great Depression: The FactsWhat was economic policy during this period?Money stock fell rapidly due to bank failures, increased currency-deposit ratio, and the failure of the Fed to take adequate expansionary measuresFiscal policy was weakFigure 19-2 shows large budget deficit

6、sAttempts to balance the budget through increased taxes contractionary policies at an inopportune timeInsert Table 19-2 here19-6The Great Depression: The Issues and IdeasWhat macroeconomic theories can explain the Great Depression?How could it have been avoided? Can it happen again?Classical economi

7、cs of the time had no well-developed theory that could explain the persistent and excessive unemployment NOR any policy mendations to solve the problemThe Great Depression and the inadequacy of prevailing economic theories was the setting for John Maynard Keynes and his great work The General Theory

8、 of Employment, Interest, and MoneyHis theory explained What had happenedWhat could have been done to prevent the Great DepressionWhat could be done to prevent future depressionsKeynesian revolution19-7The Keynesian ExplanationEssence of the Keynesian explanation of the Great Depression is contained

9、 in the simple aggregate demand modelGrowth in the 1920s based on:Mass production of the automobileMass production of the radioHousing boomCollapse in the 1930s resulted from:Drying up of investment opportunitiesReduction in consumption expendituresPoor fiscal policy 19-8The Keynesian ExplanationThe

10、 Great Depression showed:The private economy was inherently unstableActive stabilization policy needed to maintain a strong economyKeynesian model offered:An explanation of what had happenedSuggestions for policy measures that could have prevented the Great DepressionSuggestions for policy measures

11、that could prevent future depressions Vigorous use of countercyclical fiscal policy was preferred method for reducing cyclical fluctuations.19-9The Monetarist ChallengeKeynesian emphasis on fiscal policy and its downplaying of the role of money was challenged by Milton Friedman and his coworkers in

12、the 1950s.They emphasized the role of monetary policy in determining the behavior of output and pricesFriedman attacked view that monetary policy was impotent during the 1930sHe argued that the Depression was evidence of the importance of monetary factorsFailure of the Fed to prevent bank failures a

13、nd decline of money stock was largely responsible for the severity of the depressionMonetary view came close to being accepted as the orthodox explanation of the Depression19-10Money and Inflation in Ordinary Business CyclesIn examining the links between money growth and inflation, convenient to use

14、 the quantity theory of money: (1) or in growth rate form: (2) Putting inflation on the left-hand side, we have: (3)Equation (3) can be used to account for the sources of inflation. Monetarists claim that inflation is predominantly a monetary phenomenon, and velocity and output changes are small.19-

15、11Money and Inflation in Ordinary Business CyclesFigure 19-1 shows annual M2 growth and the inflation rate of the GDP deflator for the U.S.Inflation rate and money growth generally move togetherRelationship is very rough, with large gaps between the growth lines that persist for yearsChanges in outp

16、ut growth or velocity, or both, affect inflationInsert Figure 19-1 hereConclusion: Inflation is a monetary phenomenon,at least in the long run19-12HyperinflationHyperinflation: very high rates of inflation around 1,000 percent per annumTable 19-6 shows recent extreme inflation experiencesIn a hyperi

17、nflationary economy, inflation is so pervasive that is dominates daily economic lifePeople spend significant amounts of time minimizing inflationary damageInsert Table 19-6 here19-13Stopping HyperinflationAll hyperinflations come to an endDislocation of the economy es too great, and the government f

18、inds a way of reforming its budget processOften a new money is introduced and the tax system is reformedOften exchange rate of a new currency is pegged to that of a foreign currency to provide an anchor for prices and expectationsFrequently there are unsuccessful attempts at stabilization before the

19、 final successOften a coordinated attack on hyperinflation: heterodox approach to stabilizationMonetary, fiscal, and exchange rate policies combined with e policies19-14Disinflation and the Sacrifice RatioInflation reduction always costs a recession, but what exactly is the tradeoff?How much output

20、is lost through different methods of disinflation?Discussion of the costs of disinflation makes extensive use of the concept of the sacrifice ratioSacrifice ratio: ratio of the cumulative percentage loss of GDP to the reduction in inflation that is actually achievedBefore the disinflation of the 198

21、0s, economists estimated sacrifice ratios of proposed disinflation programs between 5 and 10, with the actual value was estimated to be 1.83 (Laurence Ball)19-15Deficits, Money Growth, and the Inflation TaxWhat is the link between budget deficits and inflation?We have seen that a sustained increase

22、in money growth ultimately results in increased inflationSome argue that money growth is the result of government budget deficitsThe federal government (Fed and Treasury) can finance the deficit in two ways:Sell bonds“Print money” Fed prints money when it increases the stock of high-powered money, t

23、ypically via OMO that buy up the debt that the Treasury is selling 19-16Deficits, Money Growth, and the Inflation TaxThe government budget constraint is : Budget deficit = sales of bonds + increase in money base (6)There are two types of possible links between budget deficits and money growth:In the

24、 short run, an increase in the deficit caused by expansionary fiscal policy will tend to raise nominal and real interest ratesIf the Fed is targeting interest rates it may increase the growth rate of money in an attempt to keep interest rates from risingThe government may deliberately be increasing

25、the stock of money as a means of financing itself over the long runThe Fed is said to monetize deficits when it purchases a part of the debt sold by the Treasury to finance the deficit19-17Deficits, Money Growth, and the Inflation TaxMonetization of deficits is an alternative to explicit taxationAs

26、the government creates money to finance the deficit, the money is absorbed by the public Why is the public willing to increase its holdings of nominal money balances?The public increases money holdings to offset the effects of inflation OR to maintain a constant level of real holdingsInflation acts

27、just like a tax because people are forced to spend less than their e and pay the difference to the government in exchange for extra moneyWhen the government finances its deficit by issuing money, which the public adds to its holdings of nominal balances to maintain the real value of money balances c

28、onstant, we say the government is financing itself through the inflation tax.19-18Budget Deficits: Facts and IssuesOutlays:Table 19-8 shows the outlays of the federal government since 1962Mandatory outlays: outlays made under entitlement programsEx. Social SecurityDiscretionary outlays: outlays that are governed by the congressional appropriation processEx. National defense expendituresInsert Table 19-8 here19-19Budget Deficits: Facts and IssuesReceipts:Table 19