Question

1. List and briefly explain
   1. Four costs associated with expected inflation
   2. Suppose that Brazil is in a state of hyperinflation. If the goal of the Brazilian Central Bank is to stabilize the price level, explain carefully what path the money supply should follow. (Assume that money demand depends on the nominal interest rate). Assuming that the Central Bank’s policy is successful, show and briefly explain the path of the price level, the inflation rate, the nominal interest rate, the money supply, and the level of real balances both during and after the hyperinflation.

Answer 1

Define Inflation.

Inflation: An increase in the general average price level of goods and services in the economy.

two categories of inflation

Anticipated Inflation-Costs with fully expected.

Unanticipated Inflation-Costs with unexpected.

Anticipated Inflation.

Inflation that is expected. Ex: An economy experiencing 5% annual inflation for many years and everyone was fully adjusted to it. But there are costs to it.

1) Menu Costs: associated with changing prices and printing new price lists when there is an inflation. Ex: restaurant owners, catalog producers, and others business must post prices.

2) Shoe-Leather Costs: these costs arise from trying to reduce holdings of cash. This happens as inflation decreases the value of cash people hold. People will respond by holding less cash at one time

3) :-Relative price variability and misallocation of resources

A good whose price is changed only only per year is artificially expensive at the beginning of the year and artificially cheap at the end of the year.

5) :-Inflation Induced Tax Distortions

Inflation causes taxes to be more burdensome.