CHAPTER 26 Money and Inflation 673 ORI G IN S OF IN FL ATI O NA RY MO N ETARY PO LI CY Although we now know what must occur to generate persistent rapid inflation a high rate of money growth we still can t understand why persistent high inflation occurs until we have learned how and why inflationary monetary policies come about If everyone agrees that inflation is not a good thing for an economy, why we see so much of it? Why governments pursue inflationary monetary policies? Since there is nothing intrinsically desirable about inflation and since we know that a high rate of money growth doesn t happen of its own accord, it must follow that in trying to achieve other goals, governments end up with a high money growth rate and high inflation In this section we will examine the government policies that are the most common sources of inflation High Employment Targets and Inflation The first goal most governments pursue that often results in inflation is high employment Two types of inflation can result from an activist stabilization policy to promote high employment: cost-push inflation, which occurs because of negative supply shocks or a push by workers to get higher wages, and demandpull inflation, which results when policymakers pursue policies that shift the aggregate demand curve to the right We will now use aggregate demand and supply analysis to examine how a high employment target can lead to both types of inflation In Figure 26-5, the economy is initially at point 1, the intersection of the aggregate demand curve AD1 and the short-run aggregate supply curve AS1 Suppose that workers decide to seek higher wages either because they want to increase their real wages (wages in terms of the goods and services they can buy) or because they expect inflation to be high and wish to keep up COST-PUSH INFLATION LRAS Aggregate Price Level, P AS4 P4 3* P3 2* P2 1* AS3 AS2 AS1 P1* P1 AD1 Y* FIGURE 26-5 Yn AD2 AD3 AD4 Aggregate Output, Y Cost-Push Inflation with an Activist Policy to Promote High Employment In a cost-push inflation, the leftward shifts of the short-run aggregate supply curve from AS1 to AS2 to AS3 and so on cause a government with a high employment target to shift the aggregate demand curve to the right continually to keep unemployment and output at their natural rate levels The result is a continuing rise in the price level from P1 to P2 to P3 and so on