Money Growth and Inflation

Vocabulary flashcards covering the concepts of money growth, the Quantity Theory of Money, monetary neutrality, and the various costs associated with inflation and deflation.

Inflation

A situation in which the economy’s overall price level is rising.

Deflation

A falling price level, common in the 19th century, such as when U.S. prices fell by $23\%$ between 1880 and 1896.

Quantity Theory of Money

A framework developed to explain the long-run determinants of the price level and the inflation rate.

Value of Money

Represented by the expression $\frac{1}{P}$, where $P$ is the price level; as the price level rises, this value falls.

Money Supply

A policy variable simplistically treated as being directly controlled by the Federal Reserve.

Money Demand

A reflection of how much wealth people choose to hold in liquid form, primarily determined by the average price level in the long run.

Monetary Equilibrium

In the long run, the point where the overall price level adjusts so that the quantity of money demanded equals the quantity of money supplied.

Monetary Injection

When the Fed increases the money supply, creating an excess supply of money that eventually drives up prices to restore equilibrium.

Classical Dichotomy

The theoretical separation of nominal variables (measured in monetary units) and real variables (measured in physical units).

Nominal Variables

Economic variables measured in monetary units, such as dollar wages or the price level.

Real Variables

Economic variables measured in physical units, such as real GDP, relative prices, and technology factors.

Monetary Neutrality

The principle asserting that changes in the money supply do not affect real variables in the long run.

Velocity of Money

The speed at which the typical dollar travels around the economy from person to person, denoted as $V$.

Quantity Equation

The mathematical identity $M \times V = P \times Y$, where $M$ is money supply, $V$ is velocity, $P$ is the price level, and $Y$ is real output.

Hyperinflation

Generally defined as inflation that exceeds $50\%$ per month.

Inflation Tax

The revenue a government raises by creating money; it acts as a subtle tax on everyone who holds money as the value of their cash diminishes.

Real Interest Rate

A real variable determined by the supply and demand for loanable funds.

Nominal Interest Rate

The interest rate calculated as the real interest rate plus the inflation rate.

Fisher Effect

The one-for-one adjustment of the nominal interest rate to changes in the inflation rate in the long run.

Inflation Fallacy

The mistaken belief that inflation reduces real purchasing power, ignoring that nominal incomes tend to rise alongside prices.

Shoeleather Costs

The resources wasted when inflation encourages people to reduce their money holdings, such as making more frequent trips to the bank.

Menu Costs

The physical and administrative costs firms incur to change their printed or listed prices.

Relative-Price Variability

The distortion caused by inflation where prices do not change simultaneously, impacting the market economy's ability to allocate scarce resources efficiently.

Inflation-Induced Tax Distortions

The increase in real tax burdens on saving because most taxes fail to account for how inflation exaggerates capital gains and interest income.

Arbitrary Wealth Redistribution

The process where unexpected inflation redistributes wealth from creditors to debtors because the real value of debt falls.