Money And Inflation Flashcards
Explain what is meant by “Pt < ∞t”
This states that the price level of a good must be less than the infinity for all future periods. Meaning, that if a young agent (in the current period) becomes aware that the future value of money becomes worthless, the young agent will stop working in the current period as they value leisure.
List the underlying characteristics of the simple monetary model.
Time is infinite - No set amount of periods.
2 agents: Young & Old. Total population=2N.
Young prefer leisure. Old prefer consumption.
Both agents are identical. Both agents live for 2 periods only. The population never grows.
What are the initial old endowed with? explain
Money Supply. (M/N). Old have a preference to consume. They want output, but only the young can produce this.
What are the initial young endowed with? explain
Output. As such Y=z(1-L). Young value leisure, but they can only produce output and exchange this for money.
What does stationary equilibria state?
A system of constant prices. It states that inflation in the next period will be equal to inflation in the current period (πt+1 = π).
What does the demand for real money balances graph show?
The graph essentially represents that the ability for an old agent to consume is derived from their ability to accept money and trade-off leisure for labour when they are young. Young agents must accept money if they want future consumption in the next period (when they are old).
What are the effects of an increase in the expected inflation rate on the demand for real money balances graph?
The horizontal intercept remains unchanged (No work = No consumption, as agents trade-off leisure for labour hours in exchange for money).
An increase in the expected inflation rate devalues money (M). Therefore receiving M in the current period translates to less consumption in the next; thus: BC becomes flatter.
A devaluation of M may also act as a disincentive for the young to work. The young value leisure and if M decreases they are likely to refrain from working.
An alteration in the expected inflation rate offsets both the income and substitution effects.
Qd will fall as inflation rises. Agents will opt to move away from market activities to non-cash heavy activities.
What determines the price of a good in the next period.
The price of a good in the next period is determined by the expected inflation and price of the good in the current period (as such: P2 = πP1) (P3 = πP2 etc…).
Why is money neutral in demand for real money balances?
When a one-time increase in the money supply has no effect on any real economic variables, we say that money is neutral. The reason for why money is neutral in this experiment is because the added money simply leads the initial old to bid up the price of output. Since the inflation rate is expected to remain.
unchanged after the initial price jump, the young are not motivated to supply
any more output (their demand for real money balances remains unchanged).
What does the autarky allocation show us about the role of money?
The autarky allocation has an equilibria whereby L=1 (maximised), thus C=0 (minimised). Therefore we can infer that money - as a medium of exchange - alters the way agents behave as it acts as an incentive for an agent to work for money so they can consume in the future. Without money, there is no incentive to work (stressed by the autarky allocation where L=1).
What does the autarky allocation show us about the role of money?
The autarky allocation has an equilibria whereby L=1 (maximised), thus C=0 (minimised). Therefore we can infer that money - as a medium of exchange - alters the way agents behave as it acts as an incentive for an agent to work for money so they can consume in the future. Without money, there is no incentive to work (stressed by the autarky allocation where L=1).
What is the role of money in the Demand for Real Money Balances?
Money supports to transfer things across periods. As such, an agent working when they are young generates money in the current period which is then consumed in the next period (as old agents value consumption).
