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ECON102 > Week 19 - Money and Prices Pt3 > Flashcards

Week 19 - Money and Prices Pt3 Flashcards

1
Q

What is the velocity of money (V)?

A

Velocity is a measure of the speed at which money changes hands in transactions for final goods and services.

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2
Q

What is the formula for velocity (V)?

A

V = PY/ M

(rearranged equation)
V - velocity of money
P - price level
Y - Real GDP (economic output)
M - money stock (money supply)

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3
Q

How is velocity related to nominal GDP?

A

Velocity is directly related to nominal GDP, which is the product of price level (P) and real GDP (Y):

PY = Nominal GDP

A higher velocity means money circulates more rapidly, contributing to higher nominal GDP.

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4
Q

What does a high velocity of money indicate?

A

A high velocity indicates that money changes hands quickly, leading to higher spending and faster economic activity.

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5
Q

What does a low velocity of money indicate?

A

A low velocity indicates that money is being held rather than spent, leading to slower economic activity.

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6
Q

What can cause velocity (V) to change?

A

Increased consumer confidence can lead to higher velocity as people spend more.

Economic uncertainty or fear of inflation can lead to lower velocity as people hold money instead of spending it.

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7
Q

f the money supply (M) stays constant, and velocity (V) increases, what happens to nominal GDP (P × Y)?

A

Nominal GDP (P × Y) will increase because money is circulating more rapidly in the economy.

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8
Q

What does a higher velocity of money indicate?

A

A higher velocity means the same amount of money is being used for multiple transactions in a given period, indicating a higher level of economic activity.

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9
Q

How is velocity related to inflation?

A

A high velocity is often associated with higher inflation because more money is circulating in the economy, pushing prices upward.

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10
Q

What factors influence the velocity of money (V)?

A

Technological advancements, such as ATMs, debit cards, and online payments, allow people to conduct business with less cash on hand, increasing velocity.

Changes in consumer behavior, like increased spending or saving, also affect velocity.

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11
Q

How do technologies like ATMs and debit cards affect the velocity of money?

A

These technologies allow individuals to conduct transactions quickly while carrying less cash, leading to higher velocity (more transactions per unit of money).

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12
Q

How are money supply (M) and velocity (V) related?

A

Money and velocity are inversely related:

If money supply increases but velocity decreases, total transactions may remain stable.

If velocity increases but money supply stays the same, economic activity rises without increasing the money supply.

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13
Q

What does it mean when we say money is turned over more frequently?

A

It means money is being spent more often, leading to higher velocity as the same amount of money is used for multiple transactions.

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14
Q

Why do countries allow their money supply to rise quickly?

A

Governments may issue new money to cover deficits when taxes and loans are insufficient to meet their spending needs.

Money printing is a tool used to finance government spending in the absence of alternative sources of funding.

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15
Q

How does borrowing affect the money supply?

A

Governments may borrow money to finance deficits, which leads to an increase in the money supply.

Borrowing can lead to inflation if the increase in the money supply is not matched by an increase in production.

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16
Q

What happens when the money supply increases without a corresponding increase in production?

A

Inflation occurs, often summarised by the phrase: “Too much money chasing too few goods.”

As more money is available, but goods and services remain the same, prices rise.

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17
Q

What is the ideal relationship between money supply growth and economic growth?

A

The rate of money growth should be consistent with the growth rate of the economy to avoid inflation.

If the money supply grows too quickly relative to economic output, inflation will occur.

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18
Q

What are the risks associated with printing too much money?

A

Printing excessive money can lead to hyperinflation.

Loss of confidence in the currency, which may cause the public to seek alternative stores of value (such as foreign currencies or commodities).

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19
Q

How much have prices in the U.S. risen on average over the past 60 years?

A

Prices in the U.S. have risen by about 5 percent per year on average over the past 60 years.

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20
Q

When did deflation occur in the U.S., and what does it mean?

A

Deflation (a decrease in the average price level) occurred in the 19th century.

Deflation leads to lower prices for goods and services.

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21
Q

What is hyperinflation, and where did it occur in the 1920s?

A

Hyperinflation refers to extremely high rates of inflation, typically exceeding 50 percent per month.

Germany experienced hyperinflation in the 1920s, particularly after World War I, where prices skyrocketed.

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22
Q

How much did prices rise per year in the 1970s?

A

In the 1970s, prices rose by an average of 7 percent per year, contributing to economic challenges such as stagflation.

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23
Q

What was the average inflation rate in the 1990s?

A

During the 1990s, prices rose at an average rate of 2 percent per year, indicating relatively stable inflation.

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24
Q

How does current inflation compare to previous decades?

A

Current inflation is at its highest level since the 1970s, reflecting a rise in prices after decades of lower inflation.

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25
What does the quantity theory of money explain?
The quantity theory of money explains the long-run determinants of the price level and the inflation rate by linking the amount of money in the economy to the price level.
26
How is inflation defined in an economy?
Inflation is an economy-wide phenomenon that affects the value of the medium of exchange (money). It occurs when the general level of prices rises.
27
What happens to the value of money when the price level rises?
When the price level rises, the value of money falls. This means money purchases fewer goods and services as prices increase.
28
Why is inflation a concern for the medium of exchange?
Inflation reduces the purchasing power of money, meaning that the medium of exchange is worth less over time, which can lead to economic instability.
29
What does it mean when the government raises revenue by printing money?
When the government raises revenue by printing money, it is said to levy an inflation tax. This is a way of financing government spending without increasing taxes directly.
30
How is an inflation tax similar to a regular tax?
An inflation tax is like a tax on everyone who holds money. It erodes the value of money, reducing its purchasing power, similar to how a regular tax reduces disposable income.
31
How does inflation tax affect purchasing power?
The inflation tax leads to a reduction in the value of money holdings, meaning that people need more money to buy the same amount of goods and services.
32
What is the consequence of the government’s inflationary policies?
The consequence is that individuals and businesses experience a reduction in the value of money, leading to higher prices for goods and services, which impacts purchasing power.
33
When does inflation end in an economy?
Inflation ends when the government institutes fiscal reforms, such as cuts in government spending, to reduce the need for printing money.
34
How does inflation affect the unit of account?
When the Fed increases the money supply and causes inflation, it erodes the real value of the unit of account. This makes it harder to use money as a stable measure for pricing and valuation.
35
How does inflation cause dollars at different times to have different values?
Inflation causes the real value of dollars to change over time, meaning that dollars today are worth more than dollars in the future due to rising prices.
36
How does inflation make it harder to compare real revenues, costs, and profits?
As inflation increases, it becomes more difficult to compare real revenues, costs, and profits over time, because the purchasing power of money changes, distorting financial comparisons.
37
How does inflation affect savings and investment returns?
Inflation reduces the value of savings and investment returns, as the purchasing power of money declines over time, making future returns worth less than expected.
38
What type of uncertainty does inflation create?
Inflation creates uncertainty regarding future prices and costs, making it more difficult for businesses and consumers to plan and make informed decisions about spending and investment.
39
Who led monetarist theories, and what is at the core of these theories?
Milton Friedman and the Chicago School of Economics led monetarist theories, which argue that inflation is primarily caused by an excessive growth in the money supply.
40
According to monetarists, what is the primary cause of inflation?
Monetarists believe that inflation is a monetary phenomenon caused by excessive growth in the money supply.
41
How do monetarists believe the government should control inflation?
Monetarists argue that the government should control inflation by controlling the money supply, rather than using other methods such as price controls or wage freezes.
42
What are some monetarist policy examples to control inflation?
Tight control of the money supply Reduction in government spending Privatisation and deregulation Fiscal conservatism (reducing deficits and government borrowing)
43
What does the Fiscal Theory of the Price Level (FTPL) explain?
FTPL explains the relationship between fiscal policy, the government’s budget, and the price level in an economy, arguing that the price level is primarily determined by government fiscal decisions rather than the quantity of money in circulation.
44
How does the FTPL differ from the quantity theory of money?
While the quantity theory of money asserts that the price level is determined by the money supply, the FTPL argues that the price level is ultimately determined by fiscal policy, such as the government’s budget and spending decisions.
45
According to the FTPL, which policy dominates in determining the price level?
Fiscal policy dominates monetary policy in determining the price level according to the FTPL. This means government decisions on spending and taxation play a greater role than changes in the money supply.
46
How do changes in government spending and taxation affect the price level according to the FTPL?
According to the FTPL, changes in government spending and taxation have a greater impact on the price level than changes in the money supply.
47
What role do deficits play in the FTPL?
In the FTPL, deficits may lead to inflation if the government chooses to inflate away the debt, as the real value of the debt is reduced when the government increases the money supply to pay it off.
48
Who controls the money supply in the economy?
The money supply is controlled by the Fed (Federal Reserve), which uses tools such as open-market operations to directly manage the quantity of money in circulation.
49
What are the determinants of money demand?
Money demand is influenced by factors such as interest rates and the average level of prices in the economy. People hold money as a medium of exchange, and the amount they hold depends on the prices of goods and services.
50
Why do people choose to hold money?
People hold money because it is the medium of exchange, enabling them to buy goods and services. The amount of money they hold depends on the prices of goods and services in the economy.
51
How do prices affect the demand for money?
The demand for money increases with higher prices, as people need more money to buy the same amount of goods and services. In contrast, lower prices reduce the amount of money needed.
52
How does the economy reach monetary equilibrium in the long run?
In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply. This creates monetary equilibrium where the quantity of money people want to hold matches the amount supplied by the central bank.
53
How does the overall price level in an economy adjust?
The overall price level adjusts to bring money supply and money demand into balance. This ensures that the amount of money people want to hold equals the money available in the economy.
54
What happens when the central bank increases the supply of money?
When the central bank increases the money supply, it causes the price level to rise, leading to inflation.
55
What is the relationship between money supply growth and inflation?
Persistent growth in the money supply leads to continuing inflation as more money in the economy drives up prices over time.
56
What does the principle of money neutrality state?
The principle of money neutrality asserts that changes in the quantity of money affect nominal variables (like prices and wages) but do not affect real variables (like output and employment) in the long run.
57
How can a government pay for its spending?
A government can pay for its spending by printing more money, but this can lead to inflation and erode the value of money.
58
What is an inflation tax, and what can it lead to?
Inflation tax refers to the reduction in the purchasing power of money when the government prints more money. This can result in hyperinflation, where prices rise rapidly and uncontrollably.
59
Why did inflation surge in the mid-1960s?
Starting in the mid-1960s, monetary policy was too easy, leading to a rise in inflation and inflation expectations. The excessive growth in the money supply contributed to the inflation surge.
60
What was the peak inflation rate during the Great Inflation?
Inflation peaked at about 13 percent during the Great Inflation period in the 1970s.
61
How did monetary policymakers respond to rising inflation during the Great Inflation?
When inflation began to rise, monetary policymakers responded too slowly, which allowed inflation to persist and worsen over time.
62
What were the exacerbating factors contributing to the Great Inflation?
Several factors worsened inflation, including: Oil and food price shocks Fiscal policies such as spending for the Vietnam War, which stretched the economy's capacity and contributed to inflationary pressures.
63
How did fiscal policies, such as spending for the Vietnam War, contribute to inflation?
The fiscal policies, including heavy spending for the Vietnam War, stretched the economic capacity of the U.S., putting additional pressure on prices and contributing to rising inflation.
64
What significant announcement did Chairman Volcker make in October 1979?
In October 1979, Chairman Volcker announced a dramatic break in the way that monetary policy would operate, focusing on controlling inflation.
65
What was Volcker's approach to monetary policy to combat inflation?
Volcker's approach involved high interest rates (tight money) to slow the economy and fight inflation, using disciplined and credible monetary policy.
66
What did Chairman Volcker say about breaking the inflation cycle?
Volcker stated, "To break the (inflation) cycle, we must have credible and disciplined monetary policy."
67
What was the effect of Volcker's monetary policy on inflation?
After the new, disciplined monetary policy began, inflation fell markedly, contributing to a significant reduction in inflation over the following years.
68
What was the inflation rate when Chairman Volcker left his post in 1987?
When Chairman Volcker left his post in 1987, the inflation rate was around 3 to 4 percent.
69
What was the cost of the high interest rates used to control inflation in the early 1980s?
The high interest rates required to bring down inflation led to a sharp recession during 1981-1982.
70
What was the unemployment rate during the 1981-1982 recession?
During the 1981-1982 recession, unemployment peaked at nearly 11 percent.
71
What is The Great Moderation?
The Great Moderation refers to the period from the mid-1980s through 2007, primarily under Chairman Greenspan, when both output and inflation became much less volatile.
72
How was output and inflation during the Great Inflation of the 1970s?
During the Great Inflation of the 1970s, both output and inflation were highly volatile.
73
How did monetary policy contribute to The Great Moderation?
Improved monetary policy after 1979, particularly following Volcker's disinflation, helped contribute to the Great Moderation by maintaining low and stable inflation, which promoted broader economic stability.
74
What impact did low and stable inflation have during The Great Moderation?
Low and stable inflation during The Great Moderation helped promote broader economic stability, leading to less volatility in both output and inflation.
75
What is the payment system in an economy?
The payment system is the method of conducting transactions in the economy, and it has been evolving over centuries alongside the form of money.
76
How has the payment system evolved over time?
The payment system has evolved over time, changing the way money is used and how transactions are conducted in the economy.
77
How will the future of the payment system impact the definition of money?
The future of the payment system will largely determine how money is defined and used, as technological advancements and changes in transaction methods will influence money’s form.
78
What is commodity money?
Commodity money is any money made up of precious metals or another valuable commodity.
79
When did commodity money function as the primary medium of exchange?
Commodity money functioned as the medium of exchange in most societies from ancient times until a few centuries ago.
80
What was a major drawback of using commodity money?
A major drawback of commodity money is that it was heavy and hard to transport, making it inconvenient for transactions.
81
What is paper currency?
Paper currency consists of pieces of paper that function as a medium of exchange.
82
When and where was the first paper money developed?
The first paper money, jiaozi, was developed by the Chinese Song Dynasty in the 11th century.
83
What could early paper money be redeemed for?
Early paper money was redeemable for some object of value, such as specie (precious metals like gold or silver).
84
What does backed currency mean?
Backed currency refers to paper money that carries a guarantee that it is convertible into coins or a fixed quantity of precious metal.
85
How did backed currency facilitate transactions?
Backed currency facilitated transactions by keeping precious metals safely in bank coffers, while people could use the paper money for everyday transactions.
86
What was the gold standard?
The gold standard was a monetary system used from the 1870s to 1933 in which countries tied their currency to gold, allowing paper money to be redeemed for gold.
87
Why did countries adopt the gold standard?
Countries adopted the gold standard to standardise transactions in the growing world trade market, with the commitment to redeem any amount of paper money for its value in gold.
88
What is fiat money?
Fiat money is unbacked paper currency that is not tied to any commodity but is declared legal tender by the government.
89
What does the term fiat mean?
Fiat is a Latin term meaning "let it be done," used in the sense of an order, decree, or resolution.
90
How does fiat money function?
Fiat money is paper currency that is not convertible into any commodity, and its value is determined by market forces (demand and supply).
91
Do most countries use fiat money today?
Yes, most countries in the world today use fiat money as their primary currency.
92
What are some major drawbacks of paper currency (including fiat money)?
Paper currency is easily stolen, expensive to transport in large amounts, prone to counterfeiting, and often heavily used in crime.
93
What is Kenneth Rogoff’s argument about the world and cash?
Rogoff argues that the world is drowning in cash, and that it is making us poorer and less safe, with large amounts circulating without productive use.
94
How much cash is currently in circulation according to Kenneth Rogoff?
There is a record $1.4 trillion in US dollars alone, which translates to about $4,200 per American, mostly in $100 bills.
95
What is the primary use of the excessive cash in circulation, according to Rogoff?
A large portion of the cash is used to feed illegal activities such as tax evasion, corruption, terrorism, the drug trade, human trafficking, and other parts of the global underground economy.
96
Is the excessive circulation of cash unique to the United States?
No, the excessive cash in circulation is not unique to the US, and other advanced economies also have a significant amount of cash in circulation.
97
What is an electronic payment?
An electronic payment is any transaction initiated through an electronic terminal, a computer, a telephone, an electronic device, or magnetic tape.
98
What are the key advantages of electronic payments over traditional forms like cash and checks?
Electronic payments are more convenient, cheaper, faster, and safer (though not completely safe) compared to cash and checks.
99
What is electronic money (e-money)?
E-money is money that exists only in electronic form and is used for electronic transactions.
100
What was the first form of e-money?
The first form of e-money was the debit card, allowing consumers to transfer funds directly from their bank account to a vendor’s account.
101
What are some examples of e-money that evolved after debit cards?
After debit cards, credit cards, e-cash (e.g., PayPal), and mobile payment systems emerged as popular forms of electronic money.
102
What is a two-tier payment system?
A two-tier payment system consists of two layers: The public has digital accounts with commercial banks for payments and cash withdrawals. Commercial banks hold digital accounts with the central bank to settle payments and hold reserves.
103
What is the role of the public in the two-tier payment system?
The public holds digital accounts with commercial banks, allowing them to make payments and withdraw physical cash.
104
What is the role of commercial banks in the two-tier payment system?
Commercial banks hold digital accounts with the central bank, using them to settle payments and manage reserves.
105
What role does the central bank play in the two-tier payment system?
The central bank provides digital accounts to commercial banks, facilitating payment settlement and reserve management.
106
What is a cryptocurrency?
A cryptocurrency is a digital asset designed to be a medium of exchange.
107
How is cryptocurrency decentralised?
Cryptocurrency is decentralised, meaning it is transferred peer-to-peer without requiring identification and has no centralised clearing authority.
108
What technology underpins cryptocurrency transactions?
Cryptocurrency relies on a network distributed across many computers that verifies and records transactions using cryptography and blockchain technology.
109
How are transactions conducted in cryptocurrency?
Cryptocurrency transactions are conducted peer-to-peer, meaning users exchange directly without the need for intermediaries.
110
What is a Central Bank Digital Currency (CBDC)?
A CBDC is a public or central bank-issued digital currency inspired by Bitcoin, but it is not a cryptocurrency and typically does not use a distributed ledger like blockchain.
111
What are some potential advantages of Central Bank Digital Currencies (CBDCs)?
CBDCs can offer: Fast and secure transactions Reduced transaction costs Reduced rents (e.g., fees from intermediaries) Enhanced information (e.g., for tax collection) The ability to enable negative nominal interest rates
112
What are some potential drawbacks of Central Bank Digital Currencies (CBDCs)?
Potential drawbacks of CBDCs include: Untested in periods of crisis Might affect monetary policy transmission Concentration of power in the central bank

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