Chapter 30: Money Growth and Inflation §

(F) Day of the week: Friday Class: IS206 Created Time: June 12, 2020 2:34 PM Database: Class Notes Database Date: June 12, 2020 2:34 PM Days Till Date: Passed Last Edited Time: October 20, 2021 10:06 PM Type: Lecture

Terms §

$Inflation$: price of goods & services increase while value of money falls P\uparrow \ \\downarrow$

$Deflation$: price of goods & services decrease while value of money increase P\downarrow\\uparrow$

• Value of Money: the equivalent of goods & services the money could be exchanged for
• Money Demand: the context of society determine demand and value of medium of exchange

The Value of Money §

• Price Level: calculated through CPI and GDP Deflator
• Price Level ($1/P$): the value of $1 measured in goods it can buy

Money Supply §

Who determine and affect money supply

• Central Bank\Fed: take actions to precisely control the MS
• Private Banks & Citizen

Money Demand §

How much wealth people wants to hold in liquid form, not bonds, properties…

• Money Demand negatively related to Value of Money
• Money Demand positively related to Price of Goods & Services

Real vs. Nominal Variables §

Nominal Variables: values measured in money

W = nominal wage = price of labor (15$/hour)

P = price level = price of g&s ($5/unit of output)

Real Variables: measured in physical units

• How much it’s valued through its equivalent value of another good/service
• A fixed value represented through monetary units

$RealInterestRate=NominalInterestRate-InflationRate$

Real Wage=\frac{W}{P}=\frac{\15/hour}{$5/unit\ of\ output}=3\ units\ output\ per\ hour$

• Relative Price: the price of one good relative to another

  $Good1RelativePrice=\frac{Good1}{Good2}$

The Neutrality of Money §

Monetary Neutrality: propose that changes in the money supply don’t affect real variables in the long run

$\frac{Good1}{Good2}=\frac{2\times Good1}{2\times Good2}$

The Velocity of Money §

Velocity (V): The rate at which money changes hand in the economy

$\begin{array}{rl}P\times Y=nominalGDP& =(pricelevel)\times (realGDP)\\ M& =moneysupply\\ V& =velocity\end{array}$

$$\begin{gathered} VelocityFormula:V=\frac{P\times Y}{M} \\ M\times V=P\times Y \end{gathered}$$

Nom=500

P=10

M=100

Real=Nom/P=500/10=50

v=PxReal/M=10x50/100=5

The Quantity Theory §

$M\times V=P\times Y$

1. V is stable over the long period of time
2. Y is not affected by changes in M

$2008:V=\frac{P\times Y}{M}=\frac{5\times 800}{2000}=2$

\begin{alignedat}{2} 2009: &P\times Y = V\times &M = 2\times 2100 = \ 4200\ &5% &5% \end{alignedat}$

$Inflation=\frac{P_{2009}-P_{2008}}{P_{2008}}=\frac{5.25-5}{5}=5\%$

$Inflation=\frac{P^{2009}-P_{2008}}{P_{2008}}=\frac{5.25-5}{5}=5\%$

• Inflation Tax: when tax revenue is not enough, so government print more money ⇒ hyperinflation

The Fisher Effect §

$$NominalInterestRate=InflationRate+RealInterestRate$$

Nominal Interest Rate can be changed by the government

The Cost of Inflation §

• The Shoe-leather-cost: people put money in banks for interests to counter inflation. The cost of time and transactions cost not worth giving up
• Menu Cost: the cost of changing the price tags constantly
• Misallocation of resources from relative-price variability: firms don’t change prices at the same time, relative price varies
• Cause confusion of the changing prices
• Tax Distortion: nominal income grows faster than real income
  • Income After Tax = Income - Tax

A Special Cost of Unexpected Inflation §

• Arbitrary Redistributions of Wealth: the repaying of debts while the value of currency is low

  Higher than expected inflation

  • Lender: loser | Borrower: winner

  Lower than expected

  • Lender: winner | Borrower: loser