Topic 10- Money Growth and Inflation Flashcards
The Quantity theory of money
-assumptions
M * C =P *Y
If the velocity of money is constant, then
Quantity of Money supply * Velocity of money= The Price Level * GDP
What does the quantity theory of money equation do
it relates the quantity of money, the velocity of money, and the dollar value of the eoconomy’s output of g/s
what is the velocity of money
the average number of times each dollar in money supply is used to buy g/s included in the gdp
THIS IS THE RATE AT WHICH MONEY CHANGES HANDS
V= P* Y / M
Is the velocity of money fluctuating over time?
It is stable over time
Explain each variable of
MV=PY
Velocity is the rate at which money changes hands
Y (gdp) is determined by factor supplies and tech
Money supply is changed by the central bank
P (price level)
V = P*Y / M formula significance
Velocity is stable over time, however with output determined by factors and tech, when BoC changes M, there is proportionate changes in price level and output (umerator)
SOOO when the BoC increases money supply rapidly, high rate of inflation
How to calcualte the inflation rate intuitively
MV=PY
MV=PY
Get all their growth rates (derivatives), but V is constant
SOOO
change in Money supply= Change in price + Change in output
change in price= Change in money supply= Change in output
Inflation rate formula inutitive
Growth rate of money- Growth rate of output
Inflation rate formula connotations
Growth Rate of MOney- Growth rate of GDP
If money supply grows faster than real gdp, inflation
money supply grows slower than real gdo, deflation
money supply grows at same rate ass real gdp= neither inflation or depflation
is velocity of money truly ocnstatn year over year
NO
in the long run, what deos inflaiton rate come from
results from the money supply growing faster than real gdp
hyperinflation
high rates of inflation more than 50 % per month
hyperinflation intutively
when BoC increase money supply far faster than GDP
growth rate of M- Growth rate of Y
why DOES hyperinflation happen
govts want to spend more than they can raise thorugh tax,, so they force cent bank to pruchase govt bonds and print money
steps of hyperinflation
1) high spending, not ienoguh tax revenue
2) govt cant borrow funds so they have to print money
3) large increase in money disproportione to gdp growth result in inflaiton
4) ends when govt instututies fiscal reforms scuh as cutting spending and elimnanting cretion of more new money
inflation results in fall of purchasing power
if incomes rise with prices, then it is the same purchase pwoer
if incomes rise slower than prices then purchasing power falls
menu costs
happens during inflations, firms must include chanigng orices on products and printing new catalogues constantly in their actual prices of goods
Inflation-induced tax distoriton
investors are taxes on nominal returns (inlcuding inflation) as opposed to real trurns, so it can increase how much tax they are paying
higher inflaiton=less savings
unexpected inflation on borrowing and lending
he real value of the cost of borrowing depends on inflation.
I For example, in 1980 banks were charging 18% or more on home loans
because the rate of inflation was very high. People who bought homes
were locked into high rates even when inflation subsided.
I On the other hand, if banks lend money at a low rate and then high
inflation takes place, the real interest rate they receive may be zero or
negative; thus, the risk of inflation makes banks wary of lending.
I Because inflation is often hard to predict, it imposes risk on both
people and banks that the real value of the debt will differ from that
expected when the loan is made
inflation vs deflation
deflation can be worse bc lowere prices means lower demadn for goods and services, firms lay off workers
Although the quantity theory of money is not literally correct because
the velocity of money is not constant, it is true that in the long run,
inflation results from the money supply growing faster than real GDP
Although the quantity theory of money is not literally correct because
the velocity of money is not constant, it is true that in the long run,
inflation results from the money supply growing faster than real GDP
who is hurt most by inflation
retired people and workers with fixed incomes
WHy does inflation occure in the long run
money supply grows faster than real GDP/output grows
WHAT DOES INCREASE IN PURCHASING POWER USUALLY MEAN
DEFLATION!!!!!!!!!!!!!!!!!!!!!!!!
