Question

I have a couple questions that I'm looking for help explaining as my textbook doesn't go into great detail on either subjects. Thanks!

1.) What was the “Great Inflation." What are the basic causes and types of inflation that existed?

2.) According to The Gordon Growth Model, what are the two ways that Monetary Policy affects stock prices?

Answer 1

1)The great inflation lasted from 1965-1982 ie during the second half of the twentieth century.During the 1970 period ,the condition of the stock market was very bad as it lost about 40% in 18 months.So for the next 10 yrs people stayed away from stocks.There was less economic growth and unemployment was increasing.It was a matter of serious concern for the US economy and for many other countries.Inflation in the US was high as 15%.Economists are of the view that the great inflation was due to faulty monetary policy and not because of causes like rising oil prices or rising defense expenditure during the Vietnam war.

The basic causes and types of inflation are-

Inflation is caused by excess demand or fall in supply.Aggregate demand may rise due to rise in consumer demand which will lead to rise in the price level. Increase in demand may rise following an increase in money supply due to printing of additional money.This is demand pull inflation . Cost push inflation arises due to increase in cost of production.Such increase in cost leads to rise in prices.Rising prices prompt trade unions to demand higher wages and thus the wage -price spiral starts which leads to the supply curve shifting to the left or fall in supply.

There are different types of inflation ,most prominent being demand pull inflation which is caused by rise in demand for goods,cost push inflation which is caused by rise in cost of production, creeping or mild inflation where rate of inflation is less ie 2-3%,walking inflation where rate varies between 3-4%,galloping inflation where rate is very high as 100%.Apart from these there are currency inflation caused by printing of more currency notes, credit inflation when commercial banks give more loans to people,deficit induced inflation when expenditure exceeds revenue in the budget.

2)Gordon Growth Model says that monetary policy will affect stock prices in two ways-

a)Monetary policy has a direct affect on bond return rates and this is the opportunity cost for stock investors.

b)The growth rate of the economy is also affected by monetary policy.The growth rate of the economy has a positive correlation with the expected dividend growth rate .