Inflation Flashcards
What is inflation?
- The general increase in the price level within an economy over a given period of time
What is the Quantity Theory of Money? Give the Equation
- Relates the inflation rate to the growth of the money supply
- MV = PY
- In the LR, V is fixed
- Hence, any change in M will have a direct effect on P
What is the k-value? How does it relate to money velocity
- The k-value is how much money people wish to hold for each unit of income
- Stems from real money balances,(M/P)ᵈ = kY
- Hence, as M/k = P x Y, V=1/k
What is another way to write the Quantity Theory of Money equation? What is the equation for the inflation rate that we can derive?
- %δM + %δV = %δP + %δY
- As %δV = 0 (v=fixed), we can find an inflation equation
- π = % δM - % δY
- Therefore, a Central Bank can impact Y by choosing %δM, dependant on %δY
What is the correlation between countries with higher growth and higher money supply should have increased inflation?
- 0.74
What are the ways that a Government can finance its spending?
- Borrow
- Sell Bonds
- Increase taxes
- Print money via central banks. Revenue from this is called ‘Seigniorage’, but acts as an inflation tax as purchasing power falls
What is the Fisher Equation?
- i = r + π
- As r is exogenous, δπ = δi
What is the correlation between countries with higher interest and higher nominal interest rates?
- 0.81
How do you derive that Total Savings = Total Investment?
- Set AD = AS
- AD = C(Ȳ-₸) + I(r) + Ḡ
- AS = Ȳ = F(K,L)
- Ȳ = C(Ȳ-₸) + I(r) + Ḡ
- Rearranged: Ȳ-₸ - C(Ȳ-₸) +₸-Ḡ
- Where Private savings = Ȳ-₸ - C(Ȳ-₸)
- And Public savings = ₸-Ḡ
- Total Savings = Public + Private Savings = Total Investment (r=i)
QToM Suggests that Demand for real Money Balances is proportional to Y. What effects do δi and δY have on (M/P)ᵈ?
- Increases in i reduces (M/P)ᵈ
- Increases in Y increases (M/P)ᵈ
- In the SR, reducing M will mean i will increase, shifting (M/P)ᵈ to the left
- In the LR, M will reduce and π will fall, leading to i falling
What are the two types of real interest rates? What is the difference?
- Ex-ante real interest rate: Expected real interest rate ( i - Eπ)
- Ex-post real interest rate: Actual real interest rate ( i - π)
Name the 5 Social Costs of Inflation
- Shoe-leather costs: Cost of frequent visits to banks for short-term savings
- Menu costs: Cost of constant price changes
- Relative Price Distortion: δP is infrequent, so prices aren’t always accurate
- Tax Treatment / Fiscal Drag: Capital drag doesn’t account for inflation
- Inconvenience: Complicates long-term planning
What is the balance between actual and expected inflation for lenders and borrowers?
- If π > Eπ ; purchasing power is transferred to borrowers
- If π < Eπ ; purchasing power is transferred to lenders
What are the problems with 0% inflation?
- Firms become unable to cut costs via reductions in real wages
- Non-zero inflation facilitates labour market flexibility
