Money Growth + Inflation Flashcards
Define Inflation
Increase in Overall Level of Prices
- General Price Level
Define Deflation
Decrease in Overall Level of Prices
Define Hyperinflation
Extremely high rates of Inflation
What does Inflation/Rise in P.L imply?
- People have to pay More for G+S
- Value of Money falls- 1/P
- -> Decreased Q. of G+S that can be bought with £1
What determines the Value of Money?
D + S of Money
In SR- what equilibrates D+S?
Interest Rates
In LR- what equilibrates D+S?
Price Level
What is Classical Theory of Money?
M.S determined by C.B- via OMOs + Banking System (m)
- Treat M.S as Fixed- Vertical Supply curve
M.D depends on Average Price Level, P, in the Economy
- Determined by amount of wealth people want in Liquid form
As Value of Money Increases–> M.D Decreases
In LR- Price Level, P, adjusts to where M.D = M.S
What is Quantity Theory of Money?
Growth Rate in Q. of Money
- Determines Inflation Rate
Increased Q. of Money–> Decreased Value of Money–> Increased Price Level
What is the adjustment Process for Quantity Theory of Money?
Excess M.S –> Increased D for G+S –>Increased Price of G+S –> Increased M.D –> Decreased Value of Money (1/P)
What 3 things do Monetary Injections NOT affect in LR?
- Real GDP
- Employment
- Real I.R etc.
What is Classical Dichotomy?
Theoretical separation of Nominal + Real variables
Define Nominal Variables
Variables Measured in Monetary Units
- e.g. £, $, €
Define Real Variables
Variables Measured in Physical Units
- e.g. Relative Prices, Real Wages, Real I.R
What do Developments in Monetary System influence?
Nominal Variables
- Irrelevant for explaining Real variables
What is Monetary Neutrality?
Changes in M.S do NOT affect Real Variables
- Mostly correct in LR
What is the Fisher / Velocity + Quantity equation?
MV = PY
- M = Q. of Money
- V = rate at which money changes hands in economy (velocity)
- P = Price Level
- Y = Output
What does PY show?
£ Value of Economy’s Output of G+S
What is the common notation of the Fisher Equation?
V = PY / M
What is the conclusion of the Fisher Equation?
Over LR- V is relatively Stable over time
– Y is NOT affected by Money- determined by Factor supplies
THEREFORE- only Increased M –> Increased P
- In LR- Q. of Money affects Inflation
What is the Principle of Monetary Neutrality?
Increased Rate of Money Growth–> Higher Inflation Rate
- BUT does NOT affect any Real variables
How is Real I.R calculated?
Real I.R = Nominal I.R - Inflation
=> Nominal I.R = Real I.R + Inflation Rate
What determines the Real I.R?
D + S for Loanable Funds
What determines Inflation?
Money Growth
What is the Fisher Effect?
One-for-One adjustment of Nominal I.R to Inflation when C.B Increases Money Growth
When in SR does Fisher Effect NOT hold?
If Inflation is Unexpected
What is the Inflation Tax?
Revenue Gov. raises by creating (issuing) Money
- Rather than Raise Taxes or Selling Bonds
- TAX on Everyone who Holds Money
What is the process of Inflation Tax?
Gov. Prints Money –> Increases Q. of Money –> Reduces Value of Money –> Increased Price Level
Why is the Inflation Tax roughly proportional?
Rich pay Proportionately More- hold more money
what are the 3 main costs of Inflation?
- Inflation Fallacy
- Shoe-leather Costs
- Menu Costs
What is Inflation Fallacy?
Inflation robs people of Purchasing Power of their money
- Prices Rise –> Buyers pay more
- BUT Wage earners get paid more as well
- Therefore- Relative Prices remain the Same
What are Shoe-leather costs?
Resources wasted when there is Inflation
- Encourages people to hold money in bank to Minimise Cost of Inflation Tax –> Go to Bank more often- Reduced Productivity
What are Menu Costs?
Costs of Changing Prices
- Reprinting Menus etc.
What do Market Economics + Misallocation say?
Relative Prices Allocate Scarce resources
- Inflation distorts Relative Prices –> Consumer Decisions distorted
- Markets- Less able to allocate resources to best use
What causes Arbitrary Redistribution of Wealth?
Unexpected Inflation
How does Unexpected Inflation Redistribute Wealth among Population?
Redistributes among Debtors + Creditors
- Since loans are Specified in £s
Why might Deflation be worse than Inflation?
Downward Cycle- Debt Deflation
- Cheaper to Spend later than Today –> Spending + Investment Deferred –> Decreases Output –> Decreased Real GDP –> Higher Unemployment + More Deflation
