1.5.2 Keynesian inflation theory
The eminent economist John Maynard Keynes
theorized a lot about inflation. He postulated that the money supply
had an influence on inflation in a much more complex way than the strict
monetarists suggested. Instead Keynes proposed that inflation was caused in
number of different ways: By demand outstripping supply and pulling inflation
higher, by inflation being built into the system, by higher costs pushing
inflation higher. Below are examples of each of these types of causes of
inflation.
Source: Kahn R (1976) `Inflation-Keynesian View' Scottish
Journal of political Economy: London, UK Figure 1: Inflation Keynesian
View
It was also Keynes's view that inflation expectations were
important. They impact the wage settlements that workers seek and affect other
inflation agreements that are created. These can have a marked effect on future
inflation rates. Furthermore Keynes and his followers have argued that
governments face a trade-off between unemployment and inflation i.e. if you
want full employment you may need to tolerate higher inflation. Indeed, as
Keynes was writing during the Great Depression
(1929-1933), he not surprisingly gave great importance to
reducing unemployment. This thinking paved the way for post-war governments
that were less concerned about creating inflation than their predecessors, as
they saw it as a necessary trade-off to create full employment. It is
interesting that the Keynesian theory of inflation has gone out of fashion.
This is probably related to the rejection of Keynesian thinking in
general which started in the 1970s. However Keynesian ideas
have had something of a renaissance following the Great Recession of 2008 as
governments seek alternative solutions to the problems we now face.
1.6. Exchange rates
The exchange rate between two countries is the price which
residents of those countries trade with each other. Economists distinguish
between two exchange rates: Nominal exchange rate and Real exchange rate.
1.6. a. Nominal exchange rate (e)
This is the relative price of the currency of two countries.
In other words, the nominal exchange rate is the rate at which one currency
trades against another on the foreign exchange market. The nominal exchange
rate e is defined again as the number of units of the domestic currency that
can purchase a unit of a given foreign currency. A decrease in this variable is
termed nominal appreciation of the currency. (Under the fixed exchange rate
regime, a downward adjustment of the rate e is termed revaluation.) An increase
in this variable is termed nominal depreciation of the currency. (Under the
fixed exchange rate regime, an upward adjustment of the nominal rate e
is called devaluation). When people refer to the exchange rate between
two countries, they usually mean the nominal exchange rate. So the nominal
exchange rate can be expressed as:
1.6.b. Real exchange rate (å)
This is the relative price of the goods of two countries. It
tells us the rate at which we can trade the goods of one country for good of
another. The real exchange rate R is defined as the ratio of the price level
abroad and the domestic price level, where the foreign price level is converted
into domestic currency units via the current nominal exchange rate.
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Where
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å= Real exchange rate
P* = Price of foreign good
P= Price of domestic good
e= Nominal exchange rate
A decrease in å is termed appreciation of the real
exchange rate, an increase is termed depreciation. The real rate tells how many
times more or less goods and services can be purchased abroad (after conversion
into a foreign currency) than in the domestic market for a given amount. In
practice, changes of the real exchange rate rather than its absolute level are
important. In contrast to the nominal exchange rate, the real exchange rate is
always »floating», since even in the regime of a fixed nominal
exchange rate e, the real exchange rate å
can move via price level changes. Normally, it is the nominal exchange
rate adjusted for inflation. Unlike most other real variables, this adjustment
requires accounting for price levels in two currencies. Standard models of
international risk sharing with complete asset markets predict a positive
association between relative consumption growth and real exchange-rate
depreciation across countries. The striking lack of evidence for this link the
consumption/real-exchange-rate anomaly or `Backus-Smith
puzzle' has prompted research on risk-sharing indicators with
incomplete asset markets. That research generally implies that the association
holds in forecasts, rather than realizations. Independent evidence on the weak
link between forecasts for consumption and real interest rates suggests that
the presence of 'hand-to-mouth' consumers may help to resolve the anomaly.
Developed by James Duesenberry(1946), the relative income hypothesis states
that an individual's attitude to consumption and saving is dictated more by his
income in relation to others than by abstract standard of living; the
percentage of income consumed by an individual depends on his percentile
position within the income.
It is reasonable to say that Adam Smith (1776) has played an
important role in the development of welfare theory. The reasons are at least
two: In the first place, he created the invisible hand idea that is one of the
most fundamental equilibrating relations in economic theory, the equalization
of rates of returns as enforces by a tendency of factors to move from low to
high returns through the allocations of capital to individual industries by
self-interested investors. The self-interest will results in an optimal
allocation of capital for society. He writes: «every individual is
continually exerting himself to find out the most advantageous employment for
whatever capita he can command. It is his advantage, indeed, and not that of
society, which he has in view. But the study of his own advantage naturally, or
rather necessarily leads him to prefer that employment which is most
advantageous to society». Adam Smith does not stop there but notes that
what is true for investment is true in economic activity in general.
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«Every individual necessarily labors to render the annual
revenues of the society as great as he can. He generally, indeed, neither
intends to promote the public interest, nor knows how much is promoting
it» He concludes: «It is not from the benevolence of the butcher, the
brewer or the baker, that we expect our dinner, but from the regards of their
own interest». The most famous line is probably the following: The
individual is led by an invisible hand to promote an end which was no part of
his own intention. The invisible hand is competition and this ides was present
already in the work of the brilliant and undervalued Irish economist
Richard Cantillon. He sees the invisible hand as embodied in
the central planner, guiding the economy to social optimum.
The second reason why Adam Smith played an important role in
the development of welfare theory is that, an attempt to explain the
«Water and Diamond Paradox», he came across an
important distinction in value theory. At the end of the fourth chapter of the
first book in Adam Smith's celebrated volume The Wealth of Nations
(1776), he brings up a valuation problem that is usually referred
to as the Value Paradox2. He writes.
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CHAPTER 2: ANALYSIS OF THE STATUS AND TRENDS OF
DETERMINANTS
AFFECTING AGGREGATE CONSUMPTION EXPENDITUTE IN
RWANDA
2.0 INTRODUCTION
In this chapter, the researcher analyzed the trends of
consumption and its determinants. Using tables and graphs to describe the
variable, the researcher tested the first hypothesis of these variables and
found that gross consumption expenditure and its associates have the upward
evolution. From the post-Genocide period, the wellbeing of people in the
country increased gradually. Policies to enhance the standards of living of
people in different economic sectors have been put into action.
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