Inflation
The increase in the overall level of prices
(may seem inevitable but its not. during 1900's deflation occurred)
-public views high rates of inflation as a major economic problem
-all economist decry hyperinflation, some economist argue that the costs of m
hyperinflation
an extraordinary high rate of inflation
the quantity theory of money (classical theory)
prices rise when the government prints to much money
-can explain moderate inflations such as those experience in the US, as well as hyper inflations
Classical theory of Inflation
developed by some of the earliest economic thinkers but most economist today rely on this theory to explain the long run determinants of the price level and the inflation rate
The Level of Prices and the Value of money
-inflation is more about the value of money than about the price of goods.( possibly people enjoy ice cream more but more likely peoples enjoyment remained the same and the money overtime has become less valuable)
-Inflation is an economy-wide phenomenon
Money Supply, Money Demand, and Monetary Equilibrium
supply and demand determines the value of money (Just as supply and demand for apples determines the price of apples. The supply and demand for money determines the value for money)
-the quantity of money supplied is a policy that the FED controls
-The de
Graph for Equilibrium price level
-horizontal axis shows the quantity of money
-The left vertical axis shows the value of money 1/P ( numbers go up)
-the right axis shows the price level P (inverted numbers go down) low at top, high at bottom
*** the inverted axis shows when the value of
The effects of a monetary injection
In an economy that is at equilibrium and suddenly the Fed injects money into the economy by buying some government bonds from the public in open market operations.
-The monetary injection shifts the supply curve to the right from MS1 to MS2. As a result t
The Quantity Theory of money
a theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money determines the inflation rate
**growth in the quantity of money is the primary cause of inflation
A Brief look at the Adjustment process
the immediate effect of a monetary injection is to create an excess supply of money. B4 the injection, the economy was at equilibrium but after the injection people now have more dollars in there wallet than they want. At the prevailing price level, the q
The Classical Dichotomy and Monetary Neutrality
economic variables divided into two groups
-Nominal variables=variables that are measured in monetary units(dollar prices)
-Real variables= Variables measured in physical units(relative price
-the separation of real and nominal variables is now called the
Changes in the supply of Money
according to classical analysis, affect nominal variables but not real ones. When the Central bank doubles the money supply, the price level doubles, the dollar wage doubles, and all other dollar values double. Real variables, such a production, employmen
Velocity of Money
the rate at which money changes hands
-to calculate, we divide the nominal value of output (nominal GDP) by the quantity of money.
-If P is the price level (the GDP Deflator) , Y the quantity of output (Real GDP), and M the quantity of money, then Velocit
Quantity Equation
the equation M x V = P x Y, which relates the quantity of money, the velocity of money, and the dollar value of the economy's output of goods and services
M=quantity of money
V=the velocity of money
P=the price of output
Y= the amount of output
The equati
5 steps are the essence of the quantity Theory of money
1. The velocity of money is relatively stable over time
2. Because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (P x Y)
3. The economy's output of goods and ser
Inflation Tax
the revenue the government raises by creating money ( helps build roads pay soldiers etc.)
Gov can turn to printing money to pay for its spending, the massive increases in quantity of money lead to massive inflation. Inflation ends when gov. institutes fi
Fisher effect
the one-for-one adjustment of the nominal interest rate to the inflation rate.
Nominal Interest rate=real ir+ inflation
-this way of looking at nominal interest rate is useful because different economic forces determine each of the two terms on the right
A Fall in Purchasing power? The inflation fallacy
When prices rise, buyers of goods and services pay more for what they buy. At the same time, however, sellers of goods and services get more for what they sell. Because most people earn their incomes by selling their services, such as their labor, inflati
Shoeleather Cost
the resources wasted when inflation encourages people to reduce their money holdings
-inflation tax causes deadweight losses because people wast scarce resources trying to avoid it
**The actual cost of reducing money holdings is not the wear and tear on y
Menu Cost
the cost of changing prices
-inflation increases the menu costs that firms must bear
Relative-Price Variability and the Misallocation of Resource's
Because prices change once in a while, inflation causes relative prices to vary more they other wise would, This matters because market economies rely on relative prices to allocate scarce resources. Consumers decide what to buy by comparing the quality a
Inflation-Induced Tax Distortions
Almsot all taxes distort incentives
Lawmakers fail to take inflation into account when writing tax laws so taxes become more problematic in the presence of inflation
-Inflation exaggerates the size of capital gains and inadvertently increases the tax burd
Confusion and Inconvenience
The job of the Fed is to ensure reliability of a commonly used unit of measurement. When the Fed increases the money supply and creates inflation, it erodes the real value of the unit of account
-accountants incorrectly measure firms' earnings when prices
A Special Cost of Unexpected Inflation: Arbitrary Redistributions of Wealth
Unexpected inflation redistributed wealth among the population in a way that has nothing to do with either merit or need . Theses redistributions occur because many loans in the economy are specified in term of the unit account-money
-Inflation is especia
Inflation is bad but Deflation May be worse
Deflation would lower the nominal interest rate (recall the Fischer effect) and that a lower nominal interest rate would reduce the cost of holding money. The shoeleather costs of holding money would be minimized by a nominal interest rate close to zero,