15-16 Flashcards
Inflation def
growth in prices from one period to another
what is a goods basked used for?
to compute a consumer price index
inflation (formula)
( P(t+1) -P(t) ) / P(t)
Pirce index formula
GDP Deflator = Nominal GDP / Real GDP
Consumer Price Index
- measure cost of living for consumers
- based on a representative basked of commodities
- includes goods and services bought by consumers
What is the most important inflation measure?
CPI
Producer Input Price Indexes
used to measure changes in the prices of inputs used for production
Producer Output Prices
used to measure changes in factory gate prices, excluding consumer taxes and distributors / retailers markups
economist’s perspective
- price level is just a unit of measure
- money is a veil - what matters is relative prices, not absolute prices
the real side of the economy does not…
change with the quantity of money or the level of prices (especially in the long run)
relative prices always…
reflect the relative value of goods
after some shock, prices need to …
adjust such that they again reflect the relative value of goods
When prices have time to adjust …
money is neutral in the long run
–> reflected by RBC model
–> not by Keynesian since prices adjust slowly
What is the tax system based on?
nominal accounts
What do higher wages indicate in the tax system?
- higher tax brackets
- higher taxes because of higher wages
inflation tax
if you hold cash, inflation reduces its value
real interest rate formula
r=i-pie^e
shoe leather costs
as inflation goes up
- individuals hold less cash
-they need to make more trips to the ATM
- so they spend more time when keeping cash low
=> can exceed 0.3% of GDP when inflation is 5%
Why is changing prices costly for firms?
-Physical costs
- managers involved
Is there a change if all prices increase by the same relative amount?
Yes
even if they increase by the same relative amount in the long run they do not change at the same time, staggered changes will induce changes in consumer demand, and others may react by changes their prices differently
What is the effect of prices (wages) maybe reacting slower to inflation?
consumers are temporarily poorer (real income falls)
if inflation is high, it is often …
volatile
there is evidence that high inflation leads to …
lower growth
inflation increases computational …
burden of individuals and makes them more likely to do mistakes (nominal illusion)
How can mild inflation be beneficial?
- reduces the real wage
- allows firms to hire more workers
- unemployment falls, production and economic growth increase
- grease the wheels of economy
What are the costs of deflation?
- increases the real interest rate
- high real interest rates incentivizes agents to save more and consume less
- raises the real wage
money def
money is an object used to make transactions, is accepted as a means of payment
fiat money
money that has zero value, but it has value because government legislation says so and guarantees its value
money increases the chances of …
double coincidence of wants
money delivers big efficiency gains because
- acts as a medium of exchange
- acts as a unit of account
- acts as a store of value
people need more currency if
- price per transaction (p) is high
- they make many transactions –> number of transaction Y
people want less currency if
the interest i is high
Demand for money formula
M=PY - ai
an increase in money supply
lowers the interest rate
an increase in number of transactions
raises money demand and the interest rate
bank reserves formula
R = ø * D = ø* (1-c) * M
Money Multiplier formula
1 / (c+(1-c)*ø)
Money multiplier is large when
- households deposit a lot of money with the banks c
- reserve requirements are low ø
increase in c or ø
higher demand for currency and reserves
money multiplier assumptions
- money always stays in the country
- loans make it back to banks as deposits
- banks do not hold excess reserves
seigniorage
profit made from printing money
hyperinflation
- over 50% per month
- often have origins in fiscal deficits
- government prints money since it cannot issue bonds or raise taxes
monetarism
the idea that money supply growth leads to inflation
Quantity Equation
MV = PY
