Money and Inflation (L7) Flashcards
trade
bartering (both need to want each others good)
money
roles of money
monetary units must be given (£$)
medium of exchange (widely accepted)
store of value (can spend in the future but inflation erodes value so)
cash
used for day to day transactions
demand deposits
accounting entries in electronic database in banks’ computers
settling debts
deposit ownership can be transferred
other ways to use money
saving accounts etc, less liquid
fractional-reserve banking
commercial banks create deposits and hold a fraction of them as reserves
they lend the rest either deposited to another bank or as another loan
quantity theory of money
all transactions are done with money say,
MxV=PxT
M quant of money
V money velocity (how quick money circulates around the economy)
P price of transaction
T number of transactions
nominal GDP
PxY (replacing T)
we assume Y is independent of money supply M, determined by factors of production
V is constant and M is set by central bank
finding relationship between price and money supply
rearrange for P, since V/Y is constant, it shows in the long run M determines inflation
classical dichotomy
Y is independent of M and P so producers and consumers will behave the same when relative prices haven’t changed
in the same way if money supply changes, it affects all prices so relatively nothing changes LR
neutrality of money
changes in money supply have no real effects on Y but does on prices (doesn’t work for short run analysis)
hyper inflation
high inflation (500%+)
costs of expected inflation
shoe leather costs: try to keep money in the bank to earn interest on it
menu coasts: printing new menus
costs of unexpected inflation
hurts borrowers helps lenders
hurts those with fixed nominal contracts (earn less than they think) eg retired usually have a fixed pension
