#5 Inflation

Question 1

The classical Theory of Inflation

Answer 1

Assumes prices are flexible and market is clear

Applies to long run

Question 2

The quantity theory of money

Answer 2

Linking inflation rate to the growth rate of the money supply

Question 3

The quantity theory of money begins with…

Answer 3

The concept theory of velocity

Question 4

Velocity basic concept

Answer 4

The rate at which money circulates

Question 5

Velocity

Answer 5

The number of times the average dollar bill changes hands in given time period

Question 6

Velocity equation

Answer 6

V = T / M

V - velocity
T - value of all transactions
M - money supply

Question 7

Velocity function n2

Answer 7

V = PY / M

P - price of output (GDP deflator)
Y - quantity of output (Real GDP)
PY - value of output (Nominal GDP)

Question 8

Quantity equation

Answer 8

MV = PY

Question 9

Real money balances

Answer 9

The purchasing power of the money supply

M / P

Question 10

Simple money-demand function

Answer 10

( M / P ) ^d = KY

K - how much money ppl wish to hold for each $ of income (exogenous)

Question 11

Connection between Quantity Equation and Money Demand

Answer 11

K = 1 / V

Question 12

When ppl hold lots of money relative to their income…

Answer 12

K is large, money changes hands infrequently —> V is small

Question 13

How the price level is determined:

Answer 13

1. Money supply determines nominal GDP (PY) (M)
2. Real GDP is determined by economy’s supplies of K and L and the production function
3. The price level is P = Nominal GDP / Real GDP

Question 14

The quantity theory of Money

Answer 14

/\ = 🔺M / M - 🔺Y / Y

/\ —> pi

Question 15

*

Question 16

*

Question 17

🔺Y/Y

Answer 17

Depends on growth in the factors of production and on technological progress

Question 18

The quantity theory predicts…

Answer 18

One-for-one relationship between changes in the money growth rate and changes in the inflation rate

Question 19

Seigniorage

Answer 19

The revenue raised from money creation

Question 20

The inflation tax

Answer 20

Money creation to raise revenue can cause inflation, paid by holders of money and other nominal assets

Question 21

Nominal interest rate i and inflation

Answer 21

Not adjusted for inflation

Question 22

Real interest rate r and inflation

Answer 22

adjusted for inflation

Question 23

Fisher effect equation

Answer 23

i = r + /\

Question 24

Fisher effect

Answer 24

Increase in /\ causes equal increase in i, this one-for-+e relationship is called Fisher Effect

Question 25

/\ vs E/\

Answer 25

/\ - actual inflation rate ( not known until occured )

E/\ - Expected inflation rate

Question 26

2 real interest rates

Answer 26

i - E/\ —> ex ante real interest rate, ppl expect at the time they buy a bond or take out a loan

i - /\ —> ex post real interest rate actually realized