Chapter4InflationandDeflation.pdfVIP

CHAPTER 4 INFLATION AND DEFLATION Inflation is the scourge of the modern economy. It is one of the primary persistent threats that will undermine or even destroy decades of economic growth if unleashed and not curbed. It is feared by central bankers globally and forces the execution of monetary policies that are inherently unpopular. It makes some people unfairly rich and impoverishes others. Inflation historically has destroyed entire economies and changed the course of human history. Inflation was one of the forces that unraveled the Roman Empire two millennia ago and the empire of the Soviet Union two decades ago. At the time this is being written the country of Venezuela is reeling from inflation rates of above 100% and Egyptians are rioting about higher bread and fuel prices. The impact of severe inflation often extends far beyond the economy. In the most telling story in modern history, the horrific inflation triggered by the Weimer Republic in Germany at the end of World War I caused prices to rise to such stupendous levels that the exchange rate of the German Mark to the Dollar exceeded three trillion to one! The resulting economic devastation created a political black hole from which emerged the National Socialist Party and Adolf Hitler, who exploited the ruination to become Chancellor of German in January 1933. Inflations mirror image, deflation, has less of a dark historical legacy, but is nonetheless a serious economic problem. Deflation defined price behavior during the Great Depression in the 1930s and has emerged as an economic in Japan in the current period. This chapter explores the dual economic phenomenon of inflation and deflation at an introductory level. We will begin by defining inflation and explaining how it is measured in the modern econ