Chapter 6 Flashcards
Inflation
An increase in the overall level of prices
Hyperinflation
Extremely high inflation, typically defined as inflation that exceeds 50% per month
Quantity equation
The identity stating that the product of the money supply and the velocity of money equals nominal expenditure (MV = PY); coupled with the assumption of stable velocity, an explanation of nominal expenditure called the quantity of theory of money
Transactions velocity of money
The ratio of the dollar value of all transactions to the money supply
Income velocity of money
The ratio of national income, as measured by GDP, to the money supply
Real money balances
The quantity of money expressed in terms of the quantity of goods and services it can buy; the quantity of money divided by the price level (M/P)
Money demand function
A function that shows the determinants of the demand for real money balances; for example (M/P)d = L(i, Y)
How is the economy’s price level determined?
- The factors of production and production function determine output Y
- The money supply M set by the central bank determines the nominal value of output PY
- The price level P is the ratio of PY to Y
Who has ultimate control over the rate of inflation according to the quantity theory of money?
The central bank, by keeping the money supply stable
Seigniorage
The revenue raised by the government through the creation of money; also called the inflation tax
Fisher equation
The equation stating that the nominal interest rate is the sum of the real interest rate and expected inflation (i = r + Eπ)
Fisher effect
The one-for-one influence of expected inflation on the nominal interest rate
Ex ante real interest rate
The real interest rate anticipated when a loan is made; the nominal interest rate minus expected inflation
Ex post real interest rate
The real interest rate actually realized; the nominal interest rate minus actual inflation
Shoeleather cost
The cost of inflation from reducing real money balances, such as the inconvenience of needing to make more frequent trips to the bank
Menu cost
The cost of changing a price
Costs of expected inflation
Distorting effect of inflation tax on the amount of money people hold
Induces firms to change posted prices more often
Greater variability in prices when firms change prices infrequently
Tax laws, such as capital gains tax
Inconvenience of living with changing price levels
Benefits of inflation
Can cut real wages without cutting nominal wages
Allows negative real interest rates
Costs of unexpected inflation
Redistribution of wealth
Classical dichotomy
The theoretical separation of real and nominal variables in the classical model, which implies that nominal variables do not influence real variables
Monetary neutrality
The property that a change in the money supply does not influence real variables
