Week 4 Money, banking, prices and monetary policy 2

Question 1

What are high-inflationary episodes often accompanied by?

Answer 1

High inflationary episodes are often accompanied by times of war/economic crises: use of monetary policy as a source of revenue by non-independent fiscal bodies

Question 2

What are the 2 main ways a government can finance expenditure?

Answer 2

• Taxation

* Borrowing (bond finance)- however this is just postponed taxation

Question 3

What is an additional source of revenue for governments?

Answer 3

Seigniorage

Question 4

In seigniorage, what do we assume is costless?

Answer 4

The process of the government creating money.

Question 5

What is seigniorage?

Answer 5

Seigniorage is the difference between the face value of money, such as a $10 bill or a quarter coin, and the cost to produce it.

Question 6

What rate does the government expand money supply by?

Answer 6

The government expands the money supply at

constant rate µ ≥ 1:

Question 7

What is the Seigniorage Equation?

Answer 7

St =(1 −1/µ)Mt/Pt

Question 8

What is Mt/Pt determined by?

Answer 8

The private sector

Question 9

According to a household’s optimal choice, what is her demand for real money balances?

Answer 9

qD(z, Π)

Question 10

What happens when higher expected inflation, Π, rises?

Answer 10

The demand for real money balances falls.

Question 11

What does Money market equilibrium require?

Answer 11

Equilibrium requires:
Mt/pt= NqD(z, Π)
•Mt chosen by government; 
•q chosen by agents
•pt adjusts to ensure equilibrium

Question 12

As Mt is growing at rate µ, what rate do prices grow at?

Answer 12

Π = µ

Question 13

What is the amount of seigniorage revenue that the government can raise a function of?

Answer 13

µ

Question 14

What is the full seigniorage equation, showing how much revenue a government can raise

Answer 14

Sµ =(1 −1/µ)NqD(z, Π)

Question 15

What does the Seigniorage revenue graph look like?

Answer 15

Looks like a semi circle.

Question 16

What is inflation often described as?

Answer 16

A tax

Question 17

What is the “tax rate” of seigniorage revenue?

Answer 17

(1 −1/µ)

Question 18

What is the “tax base” of seigniorage revenue?

Answer 18

NqD(z, Π)

Question 19

What happens to the tax base and rate when inflation rises?

Answer 19

• Tax rate increases

* Tax base (demand for real money balances) falls

Question 20

What do agents do if inflation is ridiculously high?

Answer 20

They do away with money and create a barter economy.

Question 21

What is the Seigniorage revenue graph’s significance?

Answer 21

There is a point after which a higher ‘tax rate’ is insufficient to cover for the decreasing ‘tax base’

Question 22

Are the highest amount of revenue and optimal level of inflation the same?

Answer 22

No

Question 23

Does the Seigniorage revenue graph have any indications of optimal welfare levels on it?

Answer 23

No

Question 24

When it seigniorage revenue often more heavily relied on?

Answer 24

After major events, when the need for spending has experienced a dramatic increase (wars) or there has been a collapse in tax revenue.

Question 25

What is a major drawback/challenge of seigniorage revenue?

Answer 25

qD is decreasing in Π

Question 26

What is the effect of increasing µ on consumption?

Answer 26

The higher µ the greater Ng∗ hence the lower the level of consumption

Question 27

Inflation has the exact same effect as a distorting income tax- true or false?

Answer 27

True

Question 28

Can we think of inflation as a “tax”?

Answer 28

Yes