term 1 lecture 1 - introduction to monetary economics

Question 1

what are the functions of money?

Answer 1

*Unit of Account: Defines the value of goods
and services
*Means of Payment: Shift towards digital
payments (e.g., credit/debit cards, bank
transfers).
*Store of Value: Subject to inflation risks,
leading to alternatives like savings accounts,
bonds, and equities.

Question 2

how is the function of money “unit of account” affected by inflation?

Answer 2

Unit of account - inflation erodes this function

Question 3

how is the function of money “means of payment” affected by inflation?

Answer 3

Means of payment
* When inflation is high , foreign currency often used for transaction
(dollarisation of economy)
* In times of hyperinflation people partially switch to barter exchange

Question 4

how is the function of money “store of value” affected by inflation?

Answer 4

Store of value
* Savings are eroded by inflation
* People use real assets such as gold and real estate Or foreign currency (dollarization)

Question 5

what are the benefits of price stability?

Answer 5

The transparency of the price mechanism
avoiding unproductive activities to hedge against the negative impact
of inflation or deflation
preventing an arbitrary redistribution of real wealth and income as a
result of unexpected inflation or deflation
Volatile inflation creates uncertainty

Question 6

why is the transparency of the price mechanism a benefit of price stability?

Answer 6

• Under price stability people can recognise changes in relative prices (i.e. prices between different goods), without being confused by changes in the overall price level.
• This allows them to make well-informed consumption and investment decisions and to allocate resources more efficiently;
• Change of relative prices reflects change in demand and helps producers to use production resources more efficiently

Question 7

why should we avoid high inflation?

Answer 7

Higher borrowing Interest rates (inflation uncertainty)
Real wage
Real wealth (savings)

Question 8

why is a higher interest rate a reason why we should avoid high inflation?

Answer 8

• creditors ask compensation for the risks associated with holding nominal assets;
• This increases the interest rate on loans
• Inflation risk premium.

Question 9

why is real wage a reason why we should avoid high inflation?

Answer 9

Rising inflation is a problem since there is a situation when workers’ real wage aspirations are systematically frustrated. There is a distributional conflict between employees and employers with a consequent social tension

Question 10

why is real wealth a reason why we should avoid high inflation?

Answer 10

If people prefer to keep wealth in the form of money (for transaction purposes, for example) then inflation is the cost of keeping money (negative rate of return).

Question 11

Negative inflation would mean falling prices. Can nominal wages be
cut?

Answer 11

Negative inflation increases the real wage and real costs of production

Question 12

what are the costs of negative inflation?

Answer 12

Decline of demand - Households wait until goods are cheaper
Reduction in the monetary value of the collateral and increase in
leverage:
* Debt is nominal, the value of collateral changes with inflation
* Deflation increases credit risk

Question 13

what are the objectives of monetary policy??

Answer 13

To maintain price stability is the primary objective of the
Eurosystem and of the single monetary policy for which it
is responsible
the natural role of monetary policy in the economy is to
maintain price stability. Monetary policy can affect real activity
only in the shorter term. But ultimately it can only influence the
price level in the economy

Question 14

what is the quantity theory of money?

Answer 14

PY = MV where P is price level , Y is output, M is the money supply and V is the velocity of moeny

Question 15

what is the velocity of money?

Answer 15

The velocity of money is a measure of the number of times that the
average unit of currency is used to purchase goods and services within a given time period

Question 16

what is the Federal reserves dual mandate?

Answer 16

The Federal Reserve has been mandated by Congress to promote
maximum employment and price stability—it’s called the Fed’s dual
mandate.

Question 17

what is the process of the federal reserves dual mandate?

Answer 17

During a recession, output is below capacity, and there are many
unemployed workers.
* the Federal Reserve uses its monetary policy tools to decrease interest rates.
* Lower interest rates encourage consumers to borrow money—for example, to buy cars or homes, and businesses to invest and expand.
* This borrowing and spending will cause firms to increase their output to meet the
growing demand.
* As output increases, firms will likely use more resources and hire additional workers. .”

Question 18

how does the interest rate change over the business cycle?

Answer 18

Interest rate declines in recession and increases in economic booms

Question 19

what does the monetary base MB consist of?

Answer 19

MB= Currency + Reserves , controlled by Central Bank

Question 20

what does the narrow money M1 consist of?

Answer 20

M1=Currency +deposits (checkable),
* “Money” as means of payment

Question 21

what does the broad money M2 consist of?

Answer 21

M2 (broad money)= Currency +deposits (checkable)+time deposits,
* less liquid than M1 but can be used as means of payment

Question 22

what is the money multiplier m?

Answer 22

m- money multiplier, it is a measure of the sensitivity of monetary policy

Question 23

what is the equation of broad money M2 in terms of the monetary base MB?

Answer 23

M2=m*MB

Question 24

what is the effect of financial stability of the multiplier?

Answer 24

Financial stability helps to stabilise the money
multiplier

Question 25

what is the equation of exchange and money supply?

Answer 25

𝑚 × 𝑀𝐵 ×𝑉 =𝑃 × 𝑌
m^(.) + MB^(.) +V^(.) = P^(.) + Y^(.) where m^(.) is the growth of the money multiplier , MB^(.) is the growth of the monetary base, V^(.) is the growth of the velocity of M2, P^(.) is inflation and Y^(.) is GDP growth rate

Question 26

complete when lecture comes out