Week 4 Money, banking, prices and monetary policy 2 Flashcards
What are high-inflationary episodes often accompanied by?
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
What are the 2 main ways a government can finance expenditure?
- Taxation
* Borrowing (bond finance)- however this is just postponed taxation
What is an additional source of revenue for governments?
Seigniorage
In seigniorage, what do we assume is costless?
The process of the government creating money.
What is seigniorage?
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.
What rate does the government expand money supply by?
The government expands the money supply at
constant rate µ ≥ 1:
What is the Seigniorage Equation?
St =(1 −1/µ)Mt/Pt
What is Mt/Pt determined by?
The private sector
According to a household’s optimal choice, what is her demand for real money balances?
qD(z, Π)
What happens when higher expected inflation, Π, rises?
The demand for real money balances falls.
What does Money market equilibrium require?
Equilibrium requires: Mt/pt= NqD(z, Π) •Mt chosen by government; •q chosen by agents •pt adjusts to ensure equilibrium
As Mt is growing at rate µ, what rate do prices grow at?
Π = µ
What is the amount of seigniorage revenue that the government can raise a function of?
µ
What is the full seigniorage equation, showing how much revenue a government can raise
Sµ =(1 −1/µ)NqD(z, Π)
What does the Seigniorage revenue graph look like?
Looks like a semi circle.
What is inflation often described as?
A tax
What is the “tax rate” of seigniorage revenue?
(1 −1/µ)
What is the “tax base” of seigniorage revenue?
NqD(z, Π)
What happens to the tax base and rate when inflation rises?
- Tax rate increases
* Tax base (demand for real money balances) falls
What do agents do if inflation is ridiculously high?
They do away with money and create a barter economy.
What is the Seigniorage revenue graph’s significance?
There is a point after which a higher ‘tax rate’ is insufficient to cover for the decreasing ‘tax base’
Are the highest amount of revenue and optimal level of inflation the same?
No
Does the Seigniorage revenue graph have any indications of optimal welfare levels on it?
No
When it seigniorage revenue often more heavily relied on?
After major events, when the need for spending has experienced a dramatic increase (wars) or there has been a collapse in tax revenue.
What is a major drawback/challenge of seigniorage revenue?
qD is decreasing in Π
What is the effect of increasing µ on consumption?
The higher µ the greater Ng∗ hence the lower the level of consumption
Inflation has the exact same effect as a distorting income tax- true or false?
True
Can we think of inflation as a “tax”?
Yes
