Ch11 - Money Growth and Inflation Flashcards
inflation def
rising prices (or a rising price level)
The percentage increase in prices from one year to the next
Measured using the CPI or the GDP deflator
deflation def
falling prices (or a falling price level)
Occurs less often than inflation
classical theory of inflation = quantity theory of money
changes in the money supply – the quantity of money in circulation – determine the price level and the value of money, but do not affect real variables in the long run
neutrality of money
the idea that changes in the price level affect nominal values, but do not affect real outcomes/values in the economy is called the neutrality of money
=> long-run
the classical dichotomy: nominal vs real variables
-> Nominal variables are measures in monetary units
- Nominal GDP (output measure in today’s dollars)
- Nominal Interest rate (growth in dollars)
- Nominal prices ($ per unit) and wages ($ per hour worked)
-> Real variables are measured in physical units
- Real GDP (out measure in base year dollars)
- Real interest rate (growth in purchasing power)
- Relative prices and wages (measured in output)
Fisher effect
real interest rate ≈ nominal interest rate − inflation rate
nominal vs real wages
The purchasing power of income in terms of output
= W / P = ($/h) / ($X/unit of output)
quantity equation and velocity
The quantity equation related the quantity of money to the nominal value of output
If V is constant and money is neutral (does not affect Y, a real variable), then changes in M affect only P
3 types of inflation
1) when M changes by more than Y changes when V is constant
2) demand-pull inflation : increase in aggregate demand during the business cycle
3) cost-push inflation : adverse supply shock: a rise in the cost of a key resources that increases aggregate supply during the business cycle
costs of low, stable inflation
Distorts relative prices, which reduces economic efficiency (produce the right amount of things)
Increase a person’s tax liability: inflation makes nominal income grow faster than real income, so that taxes on nominal income rise even when real income does not
May adversely affect pensioners and people in low income
Reduces savings and investment by reducing the real interest rate
Redistributes income from savers to borrowers
Can change price- and wage- setting behaviour, causing inflation to persist
5 costs of low/stable anticipated inflation
1) Shoe-leather costs: the money, time, and effort involved in managing money and other financial assets (analogy: more trips to the bank wear out one’s shoes)
2) Menu costs: the money, time and opportunity costs of changing prices
3) Relative price variability: price increases are staggered and incomplete, and send the wrong signals (resources are misallocated)
4) Confusion and inconvenience: inflation changes the yardstick used the measure transactions, which complicates long-range planning and the comparison of dollar amounts over time
5) Taxes: The tax system is not fully indexed for inflation -> there is not widely accepted agreement on how to do so
effects of higher-than-expected inflation
transfers purchasing power from savers (creditors) to borrowers (debtors)
inflation tax
Printing money causes inflation, which reduces the value of money
This acts like a tax: your purchasing power falls
When inflation is as expected (~2%), the amount of the inflation “tax” is “small”
Almost all hyperinflations start when the governments print money to raise revenue to pay for their spending
benefits of low stable inflation
1) Reduces the risk of the central bank causing deflation by making mistakes
2) Permits the central bank to implement expansionary monetary policy
3) Easier for firms to adjust real wages in response to changing economic conditions
