[ music][ Alex] If inflation is so costly, why do some governmentscreate inflation? In our opening videoon hyperinflation in Zimbabwe, we uttered one justification. When the government engraves moneyand uses it to buy goods, that’s like a imposition — a send of wealthfrom the people to the government. Now inflation is notan extremely effective charge. So governments typicallyuse inflation as a duty only when they’re hopeles. They can’t parent fundsin another way. There are other reasons, however, why reproducing moneycan benefit governments. And in a number of cases, engraving coin can evenbenefit an economy. We’ll be examining thesein much more detail in future videos when we discuss how the government can usefiscal and monetary policy to combat a recession.In this video, we’re just goingto give a perceive of the basic idea. Recall the equation of exchange, MV is equal to PY. Earlier, we squandered this equationto explain inflation. And what we said is that sinceV and Y are relatively stable, the only explanation for largeand sustained increases in prices is an increasein the money supply, M. We likewise established empiricallythat in the long run, when M double-dealing, then P doubles, just as the ideology foresees. In other texts, in the long run, coin is neutral. But what about the short run? In the short term, an increase in M, specially an unexpectedincrease in M, that can increase real yield. To understand why, let’s turnto the parable of inflation. Consider a small economy consisting of a baker, a accommodate, and a carpenter, who buy and sell productsamong themselves. Now think about what happenswhen a government like that in Zimbabwestarts paying its soldiers with newly etched money. At first, the baker is delighted when the soldierswalk through his door with money for bread.To slake his new clients, the baker manipulates additional hours, hires more assistants, bakes more eat, and is able to raise expenditures. “How wonderful, ” the baker guesses. With the increasein the demand for bread, I’ll be able to buy more clothesand more lockers. Meanwhile, the accommodate and the carpenter are thinking much the same thing, as the soldiers are alsobuying goods from them. When the baker arrives at the tailorto buy shirts, nonetheless, he finds that he’s been moron. The soldiers have bought shirtsfor themselves and the price of shirtshas now gone up. In the same way, the accommodate and the carpenter — they discovered that the pricesof the goods that they want to buy — they’ve also increased. Although they deserved more dollars, their real wages — the amount of goods that the baker, the adapt, and the carpenter — the amount of goodsthat they can buy with their dollars –that has decreased. When the governmentnext wants to buy goods, it faces higher premiums and it hasto reproduce even more money to buy just as many goods as before.Moreover, as the new moneyenters the economy, the baker, for example, will now race to the tailorand to the carpenter to try and spend the moneybefore prices come up. V increases. Unfortunately, the tailorand the carpenter — they’re likely to have hadthe same idea. And the research results isthat costs increase even more quicklythan the time before. Eventually, as the governmentcontinues to reproduce coin and buy goods, the baker, the tailor, and the carpenter, they’ll catch on. They’ll come to expectand prepare for inflation. Instead of making extra hours, the baker, adapt, and carpenter — they’ll realize that by the timethey get to spend their fund, the goods that they want to buy will have alreadyincreased in price.And knowing this, the baker, the tailor-make, and the carpenter — they’ll no longer be so happy to seethe soldiers entering their browse, gesticulating fistfuls of dollars. And they’ll no longerwork extra hours roasting more bread, selling more drapes, or constructing more cabinets. This is the parable of inflation. We learn two things of importancefrom the parable. First, an increase in the money supply can boost the economyin the short run. And by the way, that can be a good thing especially if there’s a recession. But this supremacy might alsobe abused by governments to help waver, say, an electoral. Second, we likewise learnfrom the parable that when the government repeatedlytries to boost the economy by infusions of money, the people come to expectthe increases in expenditures and they come to prepare. So, let’s think about thisusing our equation of exchange: MV is equal to PY. In the short run, an increasein M can cause an increase in Y.But then P catches up. So, in the long run, the increase is in P merely. But now notice the following: if the government wantsto reduce inflation, the entire processgoes into reverse. So a decrease in the money supply –that can cause a slump. If M weakens, for example, then in the short run, Y dies until P catches up. In the long run, a decreasein M decreases P. But the long run may comeonly after a short-run recession. So one of the biggestcosts of inflation is that reducing inflationis also costly. A chip of inflation –it seems like a good plan to boost the economy, but if you keep tryingthe same trick over and over again, it stops working. And then you’re leftwith all cost and no benefit. A reduction in inflationat that point — it slackens the economyand it increases unemployment. So inflation has been likenedto anti-retroviral drugs. The remedy stimulates at first, but then you need more and moreto get the same stimulus until you need the drugjust to be normal.And eventually, when you stopusing the medication, you get severe withdrawal achings. This is what happened in the United State in the early 1980 s. Inflation was increasingin the 1970 s, but by the timewe got to the late 1970 s, it wasn’t helping any longerto reduce unemployment. So, we got so-called stagflation: inflation and unemployment together. Then in the early 1980 sunder Ronald Reagan, inflation descended, but at the priceof a very serious recession in 1981 and 1982. So another reasonto avoid too much inflation is that reducing inflationcan be very costly certainly.[ Narrator] You’re on your wayto mastering fiscals. Make sure this video sticksby taking a few practice questions.Or, if you’re readyfor more macroeconomics, sounds for the next video. Still here? Check out Marginal RevolutionUniversity’s other favourite videos.[ music].
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