CH 11 - Money, Growth, Inflation

inflation and deflation

inflation- increase in price levels

deflation- fall in overall price levels

inflation rate is the percentage change in....

- CPI
-GDP deflator

(QT) quantity/classical theory of money

- theory that the quantity of money available determines the price level
- and that the growth rate in the quantity of money available determines the inflation rate
- M drives P
- AM/M drives inflation

(QT) inflation/price level can be viewed through...

- measure of value of money
- price of a basket of goods and services (ex/ price of a coke is $2, therefore $1 would buy 1/2 a coke)

(QT) how is the value and supply/demand money determined?

- By the supply and demand for money
- supply/demand of money is determined by central bank

(QT) what is the most important variable in the demand for money?

- level of prices in economy
- many other factors

ex/ if prices of all goods double, then demand for money also doubles

(QT) draw a graph representing how money supply/demand determines equilibrium price level

(LEC SLIDE 9)

(QT) what happens to the money supply/demand graph if the government increases money supply, why?

- money supply shifts right
- value of money decreases
- increases price level

(QT) what groups can economic variables be grouped into?

1. nominal variables: measured in monetary units

2. real variables: measured in physical units

(QT) define classical dichotomy & monetary neutrality

classical dichotomy: theoretical separation of nominal + real values

Monetary neutrality: money + money supply only affect nominal variables

(V) define velocity of money and it's equation

- rate at which money changes hands
V = (P x Y) / M

- p = price level
- y = real gdp
- m = money supply

(V) define, give the quantity equation

M x V = P x Y

equation relating:
- quantity of money
- money velocity
- dollar value of the economy's goods/services output

(V) what are the elements explaining the equilibrium price level? (FINISH THIS SLIDE 18-19)

1. velocity stability
2. V stability causes proportionate changes in (P x Y) (nominal value of output) when central bank changes (M)
3.

(V) what happens when the central bank rapidly increases money supply?

hyperinflation

(I) define inflation tax

revenue government raises by creating money

(I) what happens when the government prints money? how does it affect the money supply/demand graph?

- price level rises
- money is less valuable

(I) define the fisher effect

one-for-one adjustment of the nominal interest rate to the inflation rate

(I) what are the fisher effect equations?

real interest rate = (nominal interest rate - inflation rate)

nominal interest rate = (real interest rate + inflation rate)

define seigniorage and how it can effect inflation/velocity

[FINISH THIS]

(I) define menu costs

costs of changing prices

(I) describe effects of inflation on purchasing power, prices

- inflation does not reduce purchasing power as long as nominal incomes keep pace with rising prices
- income tax treats

(I) define shoeleather costs

resources wasted when inflation encourages people to reduce money holdings (money people keep available to spend)

(I) describe effects of inflation on taxes

- raises tax burden on income earned from savings
- discourages saving through tax treatment of capital gains
- income tax treats nominal interest earned on savings as income, even though it doesnt compensate for inflation

(I) define nominal interest vs real interest

nominal - interest rate paid on loan without accounting for inflation

real - interest rate accounting for inflation, reflects purchasing power changes

(I) how does inflation affect interest rates?

- raises nominal interest rates
- does not raise real interest rates
- lowers after-tax real interest rate

What are the 3 functions of money?

medium of exchange, unit of account, store of value

(I) how does inflation redistribute wealth, and why?

- inflation redistributes wealth, but not according to need or merit
- redistributions occur due to loans that are in the unit of money

Is a high inflation rate beneficial to individuals or to the bank? Why?

- high inflation is less beneficial for banks as it lowers the value of money over time