7/23/2019 Assignment 3 for macro

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Name: Pratikantham Siva Rohit Macro Economics: Assignment 3 Roll No: 1501091

1a. According to Nobel laureate Milton Friedman, “Inflation is an old, old disease. We have hadthousands of years of experience of it. There is nothing simpler than stopping inflation – from thetechnical point of view.” If inflation were a disease, then what is the cause of the disease? How do you

cure the disease? What are the effects of this disease?

Causes of Inflation:It is a monetary phenomenon. It is caused by the rapid increase in the amount of money in theeconomy than output created. Inflation increases when money is printed more than required (output).This is evident from the graphs of several countries where CPI and quantity of money per unit of money

go with each other.

3 Reasons:

1. Govt. spending (people ask Govt. to spend more, and decrease taxes). So, Govt. prints money tospend more or increase taxes. Inflation is also like a tax. It can cause indirect taxes. If bothincome and inflation grow by same %, we will be in new tax bracket, so we are pushed downeconomically.

2. To provide full employment. When unemployment rises, Govt. prints more money.3. As decrease in quantity of money lead to 1929 depression, so Federal Reserve increases money.

Cure to inflation:

Quantity of money per unit output should be increased in other words productivity should be increased.But if growth and inflation is decreased, then variation in quantity of money is more as variation inoutput and productivity. So, the better way is to Govt. spend less and print less. All the money Govt.spends comes from tax payers, so if they spend less, taxes will reduce and no need of printing. This will

lead to slow growth and low inflation.

Effects:

When Govt. prints more money, good comes first, economy boosts and output expands. And Bad effectsaffects later. Inflation rises and cost of goods rises, so salaries will be raised, and it is a vicious cycle,there will be high level of unemployment.

But when curing the disease, bad effects first and good affects later. An initial slowdown in economyand Low unemployment is a side effect for effective cure to inflation. Initially there may be high

unemployment but in a long run, there will be low unemployment.

When productivity increases, output increase; people buy more, so more demand and cost increase so

prices increase. It takes 2 years to price increase.

So, if output grows slower, it is reverse process.

In slow run, side effects are there so gradual slowdown is good. So decrease inflation slowly.

Average rate of inflation has no relation to average rate of growth or average level of unemployment.

7/23/2019 Assignment 3 for macro

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Name: Pratikantham Siva Rohit Macro Economics: Assignment 3 Roll No: 1501091

1b. Policymakers in the 1970s saw that inflation was costly, but failed to grasp that to get inflation undercontrol; they needed to use monetary policy, and only needed to use monetary policy. The fact thattoday’s policymakers do understand this reflects the profound impact of Milton Friedman on monetaryeconomics. Do you agree with the broad statement that only monetary policy can cure inflation?

Explain.

Yes, I agree that only monetary policy can cure inflation. If we consider other policies like fiscal policy orwage or price control, they are effective initially but are unsuccessful to curb inflation. “A budget deficitis inflationary if, and only if, it is financed in considerable part by printing money”— that is, only if fiscalactions are accommodated by the monetary authorities. This is said by Friedman and it is valid still andfollowed by today ’s policy makers. Increase in interest rates will decrease aggregate demand in theeconomy which will lead to slow growth which is required for low inflation. This can be done with no

intervention of fiscal policy. Increase in money supply will have late reaction on inflation and as suchDecrease will also have late reaction in reducing it. But good effects are on long term. Slow increase inmonetary growth will have initial bad effects but long term good effects like low inflation and achieve

healthy economy. Friedman also said, “Monetary policy is an appropriate and proper tool when directedat achieving price stability or a desired rate of price change.” He rightly said that at achieving pricestability or a desired rate of price change, monetary policy is proper tool as it is fast to achieve pricingand have impact on its stability. But when comes to curbing inflation it takes times as we can see fromgraph of inflation and quantity of money in US during 1960s and 70s, the effect of efforts of decreasing

quantity of money really decreased inflation only after 2-3 years.