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ECON 2H03 > Chapter 5 - inflation: its causes, effects, and social costs > Flashcards

Chapter 5 - inflation: its causes, effects, and social costs Flashcards

1
Q

recall ch2, what is inflation

A

inflation is %change in GDP deflator over period
inflation (current period) = (deflator current - old)/old

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2
Q

What is the QTM? What does it explain? what does it link?

A

how Q of money relates to economic variables (Price and income)

explains how money affects the economy in the long run

links inflation rate to growth rate of Ms

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3
Q

What is the QTM rewritten Md function

A

MV = PY

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4
Q

Define velocity, what is the equation? What is the assumption

A

velocity: number of times the average dollar bill changes hands in given period
assumption: velocity fixed and set by institutions

V = T/M (value transaactions/ms)
V = PY / M (aka PriceQuantity)/ms

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5
Q

Over time in Canada, what has driven the increase in V

A

increased ease of payment

EX. credit/debit cards, apple pay, transfers, etc.

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6
Q

What is the formula for the purchasing power of the stock of money?

A

purchasing power = M/P

expresses Q of money in terms of Q of G&S it can buy

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7
Q

what is the Money demand function?

A

(M/P)^d = k*Y

k - fraction held for each dollar of income (exogenous)

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8
Q

What is the money quantity equation?

A

MV=PY
or
M/P = (1/V)*Y

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9
Q

What is the connection between money demand and quantity equations?

what happens when people hold more/less of their income

A

k = 1/V

hold more -> k high -> V falls
hold less -> k low -> V rises

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10
Q

In deriving the QTM, what are assumptions and how does impact the money quantity equation?

A

V constant/exogenous (V = Vbar)
Y fixed (represents income and output)

money equation:
MVbar = PY

M determines P

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11
Q

In the QTM, how is price level determined?

A

P = nominal GDP / real GDP

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12
Q

how does Money supply determine nominla GDP

A

since V constant, M impacts P*Y (aka GDP)

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13
Q

what is the Quantity equation in growth rates?
what do the variables represent

A

changeM/M = changeP/P + changeY/Y

ChangeP/P = inflation (pi)
inflation = ChangeM/M - changeY/Y
aka pi = growth rate money supply - growth rate output

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14
Q

Inflation definition wrt growth rates

A

inflation: excess growth from the amount money supply needs for economic growth

inflation = Ms growth rate - Y growth rate

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15
Q

what does QTM predict:

A

1-for-1 relation b/w changes in Ms growth and inflation rate
since changY/Y depends on production factors and tech (all fixed for now)

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16
Q

in the LR, what is inflation equal to

A

LR: inflation = growth of money supply
since Y is given and fixed in LR

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17
Q

What are QTM implications on countries

A

countries with higher Ms growth should have higher inflation
LR trend in country’s inflation rate similar to LR trend in Ms growth

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18
Q

What is nominal interest rate? What is real interest rate?

A

nominal interest: paid by the bank
i = r + inflation
real interest: increase in purchasing power
r = i - inflation

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19
Q

What is the fisher effect? and fisher equation?

A

the 1-1 relationship b/w inflation rate and nominal interest rate

equation:
i = r + pi (pi=inflation)

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20
Q

using fisher effect, if money supply increases 1% in the LR, inflation will rise by what %?

A

i = r + pi
i = 0% + 1%
1% = 1% (one for one relation)

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21
Q

to prevent inflation, what does the central bank do

A

central bank reduces M growth rate to prevent inflation rising

inflation = Mgrowth - Y growth

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22
Q

What is ex ante and ex post

How does this impact the Fisher effect?

A

Ex-ante: real interest rate that borrower and lender expect when loan is made
aka expected real interest rate

Ex-post: real interest rate that is realized (actual)

New fisher effect:
i = r + pi*e (ex ante)

23
Q

QTM states that demand for real money balances depends on only ?

A

real income (Y),

direct relationship b/w M and Y

24
Q

What are the two determinants of money demand. What are the relationships with demand for money.

A

real income, Y (from QTM)
- (+) relationship: high Y -> spend rise -> Md rise
nominal interest rate, i (opp cost holding)
- (-) relationship: high rate -> people rather invest -> Md falls

25
What is the Money demand function
(M/P)^d = L(i, Y) (relations: i -, Y +) L - used for Md because money is liquid asset OR (M/P)^d = L(r+E*pi, Y) r + E*pi - nominal interest rate
26
What is the Equillibrium for Money market balances
M/P = L(r+E*Pi, Y) = (M/P)^d
27
How are the following variables determined in the LR: M, r, Y, P
M - exogenous (central bank) r - adjusts to ensure S=I (ch3) Y - Ybar = F(kbar, Lbar) (ch2) P - adjusts to ensure M/P = L(i,Y)
28
How does P respond to changeM
changes in M causes P to change by the same percentage (QTM)
29
How does expected inflation vary over SR to LR
SR: E*pi may change when obtain new info - EX. central bank announce raise M next year, people expect higher prices tf E*pi change (before anything even happens) LR: people do not consistently over/under forecast inflation E*pi = pi (on average)
30
How P responds to change E*pi
changes in expected inflation change the nominal interest rate and money demand and thus P (to adjust back to establish EQ) EX. Rise in E*pi (expected inflation) causes: 1. Rise i (the fisher effect) 2. Real money demand Fall aka. (M/P)d 3. Rise P (to make M/P fall to re-establish EQ
31
What is the LR disadvantages of inflation
currency becomes undesirable (pp falls), basket of G&S becomes increasingly more expensive reduces savings -> increases public debt
32
T or F: inflation reduces real wages
True: in SR (nominal wage fixed by contracts) False: real wage determined by labor supply and MPL (not P or pi)
33
List the costs of expected inflation (5)
Shoeleather cost menu cost relative price distortions unfair tax treatment general inconvenience
34
What are shoeleather costs?
cost of expected inflation costs of reducing money balances to avoid inflation tax if pi rise -> i rise -> Md falls Result: same monthly spending, lower holdings, more frequent/smaller cash withdrawals from bank (need more money to buy same amount of G&S, more frequent/smaller withdrawals)
35
What are menu costs
cost of expected inflation menu costs: cost of changing prices
36
what are Relative price distortions
cost of expected inflation relative price distortions: microeconomic inefficiencies in the allocation of resources due to firms facing menu costs change prices infrequently (not at the same time)
37
What is unfair tax treatment? Give an example
cost of expected inflation Unfair tax treatment: some tax not adjusted for inflation EX. Capital gains tax: buy 10$ stock sell for 11$, nominal gain is 1$. if inflation is 10%, real capital gain is 0$ YET, you pay taxes on the 1$ nominal gain
38
What are general incnvenience?
cost of expected inflation - makes harder to compare nominal values from different time periods - complicated Long-range financial planning households (needs adjust)
39
list the 2 additional cost of unexpected inflation
Arbitrary redistribution of purchasing power Increased uncertainty
40
what is Arbitrary redistribution of purchasing power? Who does it affect?
cost of unexpected inflation when pi DNE pi*E causes a redistribution of wealth within economic groups (gain at the other's expense) Who impacted: - Financial markets: lender/borrower - Labor markets: employee and employer if pi > E*Pi : pp transferred to borrowers if pi < E*pi: pp transferred to lenders
41
What is increased uncertainty and its result?
cost of unexpected inflation - inflation becomes more variable/unpredictable when high - Arbitrary distribution more likely due to larger differences in pi and pi*E result: increased uncertainty, making risk-adverse people worse off
42
What is the Benefit of inflation, in what market?
Benefit of inflation is in Labor market when nominal wages reduce -> allows real wages to reach EQM levels without making nominal wage cuts TF: moderate inflation improves functioning of labor markets
43
What is hyperinflation criteria? What is impact on costs? What happens to money function? Caused by?
criteria: when pi >= 50% per month costs: go from moderate to HUGE money: cease function 'store of value' and may not serve other (unit account, medium exchange) Cause: excessive Ms growth - printing money (if rapid enough)
44
Why would gov print money (if it causes inflation)?
to get out of continual and growing gov deficit first option: finance through taxes second option: borrow from lenders (credibility) third option: print money (central bank)
45
What is seignorage:
Seignorage: revenue raised from printing money inflation tax: printing money to raise revenue causes inflation (inflation is tax on those who hold money)
46
What is a theoretical solution to hyperinflation?
stop printing money requires drastic and painful restraint
47
What is the Classical Dichotomy? What does it imply?
the theoretical seperation of real and nominal variables in the classical model Implies: Nominal variables no effect on real variables (dollar variables don't impact Q variables)
48
Define real variables and list 4.
Real variables: measured in physical units/quantities/relative prices 1. Y (output) 2. real wage (output earned per hour) 3. r (real interest rate): output earned in future by lending out one unit today 4. Employment & Unemployment
49
Define Nominal variables and list 4
Nominal variables: measured in dollars 1. Nominal wage: dollars per hour work 2. Nominal interest rate (i): dollars earned in future by lending one dollar today 3. Price level (P): amount $ to buy basket 4. Money supply (Ms)
50
What is the Neutrality of money
changes in Ms no affect on real variables in LR TF: monetary policy can not effect: - output, employment, r, real wage
51
Given the neutrality of money, what happens in SR vs LR if fiscal policy changes?
Bank cannot change Ms to impact Y or U/L SR: policy may impact LRL only bring inflation
52
What is defining LR and SR on a macro level
SR: prices all fixed (inputs and outputs) LR: prices all flexible
53
What is defining LR and SR on a micro level
SR: business can change min 1 input LR: assume no fixed variables (all change)
54
in classical dichotomy, what determines the price level of all nominal variables
money market EQM

ECON 2H03 (8 decks)

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