Central Bank, inflation, deflation, interest rates, Bretton-Woods agreement, oil, exchange rate, currency, prices of goods, demand, GPD Gross domestic product, hyperinflation, salary, decision-making, deflator, measures, data set, output gaps, central bank tool-kit, short-term interest rate, Federal Open Market Committee function, FOMC Federal Open Market Committee, Fed Funds rate, statements, market price, Ben Bernanke, interest rate probabilities, money supply-interest rate
Inflation was a major problem in the 1970s. The 1971 collapse of the Bretton-Woods agreement gave governments latitude to alter their currency exchange rates. The previously locked exchange rates had the effect of taming inflation. There were also "oil shocks" in 1973 and 1979, which caused oil prices to spike. Oil was a major cost in the industrial economy at the time, so these shocks spurred inflation.
[...] Let's see how the manipulation of short-term interest rates by a central bank has, in the past, set the economy back on the right track. Here is the output gap chart we looked at earlier. Let's overlay the Fed Funds rate, the short-term interest rate controlled by the Fed. The output gap helps explain the Federal Reserve rate decisions. In the booming late 1980s, the economy was tight and rates went up. In the early 1990s recession, the economy had some slack and rates were cut sharply. [...]
[...] Let's discuss Goldilocks and the Three Bears. Her goal was to eat porridge of just the right temperature: not too hot and not too cold. For central banks, the porridge is the right temperature when inflation is subdued, which provides a stable backdrop for businesses and consumers. The porridge is too hot when inflation is high. This is typically caused by excessive economic growth. The porridge is too cold when there is deflation. This is typically caused by a lack of economic growth. [...]
[...] This shows a list of forthcoming FOMC meetings, and the probability of a hike or cut at each meeting. The chart shows the evolution of predictions about FOMC decisions for a given meeting. At the time this screen was captured on February Fed rates were set between 0.50 and 0.75%. The red line shows the percent chance of a rate cut at the next FOMC meeting on March 15. The futures and options market gave a chance of a rate cut. [...]
[...] This is the essence of inflation. As you can see in this table, major wars involving the United States were accompanied by high inflation. If you thought those numbers were bad, Germany suffered from 24,380% inflation per month shortly after World War I. That means, for example, that a piece of candy that cost $0.02 at the start of January would cost about $4.88 at the end of it. According to some sources, in November 2008 Zimbabwe suffered from a peak inflation of 89.7 sextillion percent. [...]
[...] While this may sound like a small difference, $1M would feel like $562,000 in Italy afte being eroded by inflation over 30 years. Meanwhile, $1M in Mexico would feel like just $250,000. Small differences in inflation expectations compound and are highly corrosive to bond prices. No wonder bond investors look hawkishly for signs of inflation. The output gaps The other main temperature gauge is the output gap, which is the difference between the economy's potential output and its actual output. Tightness in the economy frequently coincides with inflation, while slackness frequently coincides with deflation. [...]
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