Chapter 5- Inflation Flashcards
Define hyperinflation
What causes it?
How to stop it?
Extraordinarily high inflation more than 50% per month
It is due to excessive growth in the supply of money.
Central bank has to reduce money supply.
Why people hold money? And when do they need to hold more money?
To buy thing.
They hold more money when they need to hold more things.
Define quantity equation
The link between transactions and money
Money * velocity = price * real GDP
Explain the components of quantity equation
Money: total amount of money in circulation in the economy
Velocity: transactions velocity of money (the rate at which money circulates in the economy)
Price: the price of a transactions. It is the GDP defaltor.
Total output of the economy: real GDP
Price * total output = nominal GDP
What happens when money in circulation increases but the velocity does not change?
Price or transactions must rise
Define income velocity of money? Which part of the quantity equation is called like this?
Number of times a dollar enter someone’s income in a given period of tome.
Velocity is called like this
Define real money balance
What it measures?
It is equal to money/price
It is a way to express the quantity of money in terms of the quantity of goods and services it can buy.
It measures the purchasing power of the stock of money
Define money demand function
Equation shows the determinants of the quantity of real money balances people wish to hold.
It means that, higher income leads to greater demand for real money balances.
What happens when people hold less money?
Money circulate more times between hands
Define quantity theory of money.
How Quantity of money affects GDP?
The assumption that V in PY=MV is constant.
Therefore V = nominal GDP \ M
Assuming V is fixed, then quantity of money determines GDP
What are the 3 building blocks of the determinant theory of economy’s overall level of prices?
- Factors of production and the production function determines level of output of the economy (GDP)
- The money supply (set by the central bank) determines the nominal GDP
- Price level P = nominal GDP/Y
According to the quantity theory of money, who controls the rate of inflation?
The central bank has ultimate control over the rate of inflation
How governments raise revenue?
Define seigniorage
- Taxes
- Borrow from the public (government bonds)
- Print money
Seigniorage is the revenue raised by the printing of money
What happens when the goverment prints money?
It raises money supply therefore inflation increases.
Who pays the burden of inflation?
Holders of money
What is the equation of real interest rate?
Real interest rate = nominal int.. rate - inflation
What is the fisher equation? What it shows?
Nominal = Ex ante real interest+ expected inflation
It shows that nominal interest rate can change either because of a change in inflation or change in real interest rate
Therefore, 1% increase in inflation leads to 1% increase in nominal interest rate
Define ex ante and ex post
Ex ante: expected interest rate
It equals = ex ante real interest + ex ante inflation
ex post: actually realized interest rate
It equals = ex post real interest + ex post inflation
What is the opportunity cost of holding money?
Nominal interest rate
What higher interest rate causes?
Lower demand for real money balances
What expectations of higher money growth in the future does to the present?
Higher prices
