Chapter 17 Flashcards
Inflation
Increase in the overall level of prices
Deflation
Decrease in the overall level of prices
Disinflation
Decrease in the inflation rate
Hyperinflation
Extraordinarily high rate of inflation
Classical theory of money
- Quantity theory of money
- Explain the long-run determinants of the price level
- Explain the inflation rate
Inflation: rise in the price level
- Lower value of money
2. Each dollar buys a smaller quantity of goods and services
Money demand
Reflects how much wealth people want to hold in liquid form
Demand curve – downward sloping
Money supply
Determined by the Fed and the banking system
Supply curve is vertical
The Fed Doubles Money Supply
- Supply curve shifts right
- Value of money decreases
- Price level increases
Quantity theory of money
- The quantity of money available in the economy determines (the value of money) the price level
- Growth rate in quantity of money available determines the inflation rate
Nominal variables
Variables measured in monetary units
EX.)Dollar prices
Real variables
Variables measured in physical units
EX.)Relative prices, real wages, real interest rate
Classical dichotomy
- Influence nominal variables
2. Irrelevant for explaining real variables
Monetary neutrality
Changes in money supply don’t affect real variables
Velocity of money (V)
V = (P × Y) / M P = price level (GDP deflator) Y = real GDP M = quantity of money
Rate at which money changes hands
Average number of times a dollar has been spent in a year
Relatively stable over time
Quantity equation
M × V = P × Y
Quantity Theory of Money
M × V = P × Y
Y = (M × V)/P
In a demand side recession output falls and there is pressure on prices to decrease
Increases in money supply M do not increase prices in the short run
Velocity of money is not always constant
Increasing the money supply can lead to short run increases in output
The inflation tax
Revenue the government raises by creating (printing) money
Like a tax on everyone who holds money
Fisher Effect
Real interest rate = Nominal interest rate – Inflation rate
Nominal interest rate = Real interest rate + Inflation rate
Fisher effect:When the Fed increases the rate of money growth
Long-run result
Higher inflation rate
Higher nominal interest rate
Shoeleather costs
Resources wasted when inflation encourages people to reduce their money holdings
Menu Costs
Costs of changing prices
Market Economies:Inflation
1.Inflation distorts relative prices
A)Consumer decisions are distorted
B)Markets are less able to allocate resources to their best use
Higher Inflation
Increases the Tax Burden
When the Fed increases money supply
Creates Inflation
Decreases the Value of Money
Unexpected inflation
Redistributes wealth among the population
Not by merit
Not by need
Redistribute wealth among debtors and creditors
The Friedman rule: moderate deflation will
Lower the nominal interest rate
Reduce the cost of holding money
Shoeleather costs of holding money - minimized by a nominal interest rate close to zero
Deflation equal to the real interest rate
Costs of deflation
Menu costs
Relative-price variability
If not steady and predictable
Redistribution of wealth toward creditors and away from debtors
Arises because of broader macroeconomic difficulties
Symptom of deeper economic problems
