Inflation and deflation- Monetarism

The problems, causes and policies

What is money?

Any object that is generally accepted as payment for goods and services and repayment of debts.

What is the acronym used to describe the characteristics of money?

• Portable 

• Acceptable 

• Divisible 

• Durable 

• Limited 

• Extremely hard to forge 

• Recognisable 

What are the functions of money?

• Medium for exchange, overcomes the need for the double coincidence of wants 

• Store of value 

• Unit of account, compare business activity 

• Standard of deferred payment

What is the money supply?

Measures the total amount of money in the economy at a particular time. 

What is narrow money?

This is physical money: the level of notes and coins in circulation.

What is broad money?

This is notes and coins in circulation plus private sector deposits in banks and buildings societies. 

What is the monetarist view of inflation?

Equates increases in the money supply with increases in the price level.

What is the fisher equation of exchange?

M x V ≡ P x T

What does M stand for in the fisher equation of exchange?

The money supply in an economy

What does V stand for in the fisher equation of exchange? 

The velocity of circulation - the average number of times that money changes hands. 

What does P stand for in the fisher equation of exchange?

The average price level in an economy. 

What does T stand for in the fisher equation of exchange?

The number of transactions that take place in an economy. 

What is the quantity theory of money?

Adapts the basic exchange question by stating that V and T are largely stable and predictable.

Why don’t V and T change in the quantity theory of money?

V is based on the spending habits of households and T is based on output not changing much in the UK.

According to the quantity theory of money, what will a change in the money supply cause?

Due to V and T not changing, any change in M over and above the percentage change in T will lead to a change in P.

Is the quantity theory of money a Keynesian or classical view point?

This is a classical view point.

What are the limitations of assuming V and T are stable and predictable?

• V changes if there are changes in the way in which workers are paid 

• V changes with the introduction of money substitutes 

• V changes with speculation in financial markets