3- Inflation Flashcards
How does inflation distort the progressive tax system?
Increase in nominal wage to ensure constant real wage can push individuals into a higher tax bracket
How does an increase in the money-supply affect inflation?
If more money is bidding for the same amount of goods the price of goods increases and the value of money decreases
How can you express growth rate of money supply (z) in terms of money supply (Mₜ)?
Mₜ = zMₜ₋₁
How many units of fiat money are printed every period?
Mₜ - Mₜ₋₁ = Mₜ - Mₜ/z = (1 - 1/z)Mₜ
What are the 2 ways central banks inject newly printed money into the economy?
-Distribute the money directly to agents via lump-sum transfers
-Give the newly printed money to the government
What defines a money transfer as ‘lump-sum’
If the amount given to someone doesn’t depend on any decision made by that particular person
How is money injected into the economy in the OLG model?
Lump-sum transfer every period to each old person worth aₜ units of goods:
aₜ = (1 - 1/z)vₜMₜ/Nₜ₋₁
What is the individual budget constraint for the old when money is injected in the OLG model?
Consumption in old period cannot exceed real value of money generated when young
c₂ = vₜ₊₁Mₜ + aₜ₊₁
What is the lifetime budget constraint with lump-sum transfers?
c₁ + zc₂ = y + za
Future consumption and future transfer discounted at the rate of return of money
How can you express growth rate of money supply (z) in terms of real money value (v)?
z = vₜ/vₜ₊₁
What happens to the gradient of the budget line with positive money growth?
The budget line becomes flatter because more units must be sold when young to get an extra unit when old
Why is the market solution with inflation inefficient?
Inflation distorts agents’ choices by holding less money to avoid erosion consuming more than optimal when young and less than optimal when old
Outline the concept of inflation tax
Expansion of monetary stock lowers return of fiat money
Why is constant money supply (z=1) optimal monetary policy?
No distortion so for each good not consumed by a young person, an old person can consume n goods
Why is it optimal to have a positive inflation rate when the population is shrinking (n<1)?
-Fewer young people in next period meaning fewer goods in economy
-Giving up one good when young yields less than 1 good when old so the value of money goes down across time
