Money Growth, Inflation And Business Cycle Flashcards
What distinguishes money from other assets in the economy?
Money can be defined as an asset in an economy that people regularly use to buy goods from other people. It is the most widely accepted medium of exchange thus trading with the highest liquidity.
What is commodity money? What is fiat money? Which kind do we use?
Commodity money: a money that takes the form of commodity with intrinsic value.
Fiat money: fiat, Latin word for “so be it”. Money that has no I stringed value but is used because of government degree.
All modern currencies, we presently use, are fiat money.
If the central bank wants to increase the money supply with outright open-market operations, what does it do?
The outright (direct) sale or purchase of non-monetary assets without a corresponding agreement to reverse the transaction at a later time. Effectively, the central bank trades newly created money for non-monetary assets thus increasing the supply of money in the economy. They are conducted via a so called primary dealers.
Why has the ECB lowered its target for the discount rate?
Ten target rate was lowered in order to decrease interest payments for both private and state borrowers.
What effects does the ECB hope for?
The ECB hopes that the newly created money will enter the real economy, thus creating new demand by businesses and consumers.
When will the ECB change course?
The ECB will change course if the newly created money will result in inflationary pressure as the CPI rises substantially.
The term”inflation” is used for two different phenomena. Explain them. Which is cause and which is effect?
Inflation is used in the sense of classical economist is used for increase in the supply money. Nowadays it is used to describe an increase in the general price level usually measured through the CPI.
Inflation - the creating of new unpacked money is the cause, an increase in price level the effect.
Explain the effects of deflation for creditors and for de tors. Who benefits, who loses?
Debtors : the debtors lose from deflation as they have to repay the loan with money, which has increased in purchasing power.
Creditors: the creditors gain from deflation as they receive money which has higher purchasing power than they initially lent out to the debtors.
Explain the Cantillon effect.
Means that newly created money does not enter the economy evenly, but rather some institutions receive the new money first. Hence, they have the possibility to purchase real goods and services with the newly created money at old prices.
The Cantillon effect describes the redistribution of real goods due to inflation.
Explain the impact of an increase in the money supply on the purchasing power of money.
The purchasing power of money diminishes as new money is created our of thin air. Via the Cantillon effect every increase increase in the money supply leads to a redistribution of existing economic goods.
Further diminishing the purchasing power via an increase in the money supply results in hidden taxation of all money holders.
How is the central bank policy linked to the business cycle?
Central bank sets the main interest rates, which serve as a basis for commercial bank leading. The lower the interest rate, the more consumer and businesses are incentivized to take on new loans. These loans, artificially created and not backed up by real savings lead to an unsustainable boom.
Define the following terms: boom, recession, depression, countercyclical
Boom: the real output peaks; the economy is on its height in the business cycle.
Recession: a period of declining income and rising unemployment. Economists speak of a recession after two successive quarters of economic growth.
Depression: a severe and long lasting recession. Unemployment stays high and output does not recover to pre-depression levels.
Countercyclical: moving in the opposite direction of the overall economic trend.
What is the difference between economic growth due to increased savings and a boom due to artificially lowered interest rates?
Sustainable growth leads to higher wealth without any cyclical distortions. No underconsumption occurs, but rather a shift in demand to capital intense production takes place. Unsustainable growth leaders to a breakdown of the artificially created boom.
What does a decrease of the general price level mean for employees and employers?
Employers: real wages are likely to increase, as nominal wages are unusually sticky and adjust slowly to changes in CPI. Employers could potentially react with lay-offs of existing personnel.
Employees: purchasing power of money increases as real wages increase.
Why does in a barter economy potentially less interpersonal trade occur?
A barter economy necessarily requires a double coincidence of wants (the exchange of one direct good for another) which is hardly the case for any transaction made in developed economies.
