Chapter 7 Concepts and Terms Flashcards
equation of exchange
MV = PQ, where
• M is the money supply
• P is the price level
• Q is the amount of output produced by the economy
The Equation at a deeper level of understanding…
Here are what the equation means. Since P is the price of the output and Q is the amount of the output, PQ is the amount spent on the output at the current price level—the total amount of spending in the economy. ***This amount is currently more than $15 trillion (really $17.3T). Earlier, we saw that M1 is about $2.5T (it is $2.9T). If we substitute for what we know,
$2.5 trillion x V = $15 trillion
With some algebra, we find V = 6. But we have not yet defined V. However, V answers this question. “How can 2.5 trillion dollars purchase the 15 trillion dollars’ worth of output that was produced during the year?”
The average number of times that $1 turns over is called
V—velocity
the interpretation of the equation of exchange
MV = PQ just means that the output in the economy is bought by the money supply, which is spent and re-spent at a rate of V.
Milton Friedman founded the monetarist school of economics. His book, A Monetary History of the United States, coauthored with Anna Schwartz, published in 1963, changed the economics profession. Monetarism begins with the equation of exchange, then softens the assumptions of the simple quantity theory.
With these two additions to the simple quantity theory, we consider the equation of exchange: MV = PQ, stating the assumptions of monetarism. On the left hand side, velocity can be considered stable. On the right hand side, output can vary somewhat in the short run, but in the long run tends toward its potential, which occurs where the labor market is in equilibrium.
nominal interest rate
the rate that is advertised, which shows up on your financial statements
real interest rate
when banks formulate their nominal interest rate, based on what they expect inflation to be
secured loans
Loans with this kind of asset backing
unsecured loans
there is usually nothing backing the loan
The idea that money creation fuels inflationary bubbles, which burst and cause unemployment, was formulated by the Austrian economists Ludwig von Mises and Freidrich Von Hayek. Today in the economics profession the “Austrian school” uses a method of analysis practiced by many economists who are not necessarily from Austria.
Austrian economists view the overall spontaneous order of the market—based on tastes, knowledge, and scarcity, all connected by prices—as stable. In order for the entire economy to be destabilized, something must go wrong with the connections—something must go wrong with prices, in general. The thing that all prices have in common is the money supply, so the Austrians say that errors by central banks must be the root of all destabilization in the economy.
monetizing the debt
when a central bank, such as the Fed, attempts to assist the state in its borrowing by purchasing debt in return for dollars, we say they are….
the inflationary tax
When the state creates inflation in order to reduce the value of its debt, it is said to impose…
