Chapter 11 - Money Growth And Inflation Flashcards
Liquidity preference and what influences it
How much cash you have on you
- accessibility (ATMs, cards), price level (don’t need as much if things are cheap)
Graph - how the supply and demand for money determines the equilibrium price level
- right side axis: value of money (1/P), 0-1(high)
_ Left side axis: price level (P), value decreases as u go up, 1 is low - money supply curve is vertical bc it’s fixed
- money demand curve downward curve as usual
- where they meet us equilibrium value of money and equilibrium price level
What would happen is the supply of money was doubled and drop around from helicopters
Prices would double
Value of dollar will decrease bc more in circulation
Would devalue our dollar
Would increase exports and decrease imports
Quantity theory of money
Theory saying that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines inflation rate
Graph showing increase in supply lowers value of money (right side) and increases price level (left side)
How does the economy get from the old to the new equilibrium
- monetary injection creates an excess supply of money
- At that price level, the quantity of money supplied now exceeds the quantity demanded
- The injection of money increases the demand for g/s while supply remains unchanged
- the prices of g/s increase
- quantity of money demanded increases until the economy reaches a new equilibrium
2 groups of economic variables
Nominal variables - measured in monetary units (measured in price, can be irrelevant bc price level can change)
Real variables - measured in physical units (trading objects for objects)
Classical dichotomy ,
Theoretical separation of nominal and real variables
Monetary neutrality
Proposition that changes in the money supply do not affect real variables
Velocity of money
The rate at which money changes hands
V = (PxY)/M
V - velocity of money (how fast it circulated)
Y - Real GDP
P - price level (GDP deflator or consumer price index)
M - quantity of money
Quantity equation
Equation that related the quantity of money, the velocity of money, and the dollar value of economy’s outputs
M x V = P x Y
Because V is stable over time, when central bank changes M, it causes proportionate changes in nominal value of output (P x Y)
Inflation tax
The revenue the govt raises by creating money, more subtle than other taxes. Govt prints money, price level rises, and the dollars in your pocket are less valuable
Fisher effect
One-for-one adjustment of the nominal interest rate to the inflation rate
Real interest rate = nominal interest rate - inflation rate
Nominal interest rate = real interest rate + inflation
Costs of inflation
- Shoe leather costs - resources wasted when inflation encourages people to reduce their money holdings (have to go to the bank more often to get more cash)
- Menu costs - costs of changing princes (price tags…)
How inflation affects wealth distribution
Unexpected inflation redistributed wealth among the population in a way that has nothing to do with merit or need (retired people get same money, but price levels are rising)
Nominal GDP equation
Nominal GDP = real GDP x price level
