Download MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT

MACROECONOMICS
AND THE GLOBAL BUSINESS ENVIRONMENT
2nd edition
Money and Prices
1
11-2
Key Concepts
 Inflation


Hyperinflation
Inflation Tax and Seignorage
 Monetarism
 Money Neutrality
 Quantity Theory
11-3
Inflation
 The rate of change in the price level
P(1) – P(0)
Rate of Inflation =
P(0)
11-4
UK Prices, 1661 - 1991
11-5
UK Inflation, 1661 - 1999
11-6
U.S. Prices, 1800 - 2000
11-7
G7 Inflation, 1975 - 2000
30
Canada
25
USA
France
20
Germany
15
Italy
10
Japan
5
UK
0
-5
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
11-8
Measuring Inflation
 Consumer Price Index (CPI)
 Producers’ Price Index (PPI)
 GDP Deflator

Ratio of Nominal GDP to Real GDP
 Mis-measurement issues


Substitution
Quality
11-9
Money Neutrality
 Price level is a yardstick

Nominal measure
 Does it matter which unit we use?


Double all prices and incomes
Is your welfare the same, better, or worse?
11-10
Costs of Inflation
 Tax system
 Bracket creep
 Shoe Leather costs
 Menu costs
 Transactions costs associated with changing prices
 Relative price issues
 Price signal sends wrong message
 Unexpected inflation
 Harms savers
 Effect on long-run growth
11-11
What about deflation?
 Two types of deflation

Demand-induced



Price uncertainty
High ex-post real interest rates
Real burden of debt
 Unexpected deflation

Supply-induced
11-12
Money
Money was never a big motivation for me, except as a way to
keep score. The real excitement is playing the game.
Donald Trump, "Trump: Art of the Deal"
Money is a terrible master but an excellent servant.
Phineas Taylor Barnum
A billion here, a billion there - pretty soon it adds up to real
money.
Senator Everett Dirksen (1896 - 1969)
11-13
Money
 Why money
 Eliminates double coincident of wants problem
facing barter economy
 Role of money
 Store of value
 Medium of exchange
 Unit of account
 Kinds of money
 Commodity Money
 Backed currency
 Fiat Currency
11-14
Money
11-15
11-16
11-17
The Money Supply
 M1:



Currency
Checkable deposits (i.e. demand deposits)
Traveler’s Checks
 M2:



M1
Savings and small time deposits (including
money market deposit accounts)
Retail money market mutual funds
11-18
Monetary Aggregates, (Billions $)
M3
Source: Board of Governors On-line Statistics
11-19
Money Multiplier
Vault Accumulation
$10
$19
$26.10
…
$100
$90
$71
…
$100
$190
$261
Total Money
Base Currency
$100
… $1000
M1
11-20
Money Multiplier
Deposits
Needed Reserves (10%)
Lend Out
$1,000,000
$100,000
$900,000
900,000
90,000
810,000
810,000
81,000
729,000
729,000
72,900
656,100
.
.
.
.
.
.
.
$10,000,000
.
$1,000,000
.
$9,000,000
11-21
Money Multiplier = 1/(reserve requirement)
 Assumes banks don’t hold excess reserves
 Assumes loans make it back to bank as
deposits
 Assumes currency doesn’t leave country
 3 parties that help determine money supply



Central bank
Private banks
Individuals
11-22
Seignorage
 How does it work?
 Direct – print money
 Indirect – print money, buy and hold
government debt
 Inflation Tax
 Decline in value of cash holdings due to
inflation
 Seignorage can be the same as the inflation
tax
11-23
Hyperinflation
 High and persistent rate of inflation
 Relationship to fiscal policy
Finance government.
spending via inflation
tax
Rising Inflation
Declining value of Money
People decrease
money holdings by
buying goods
11-24
The German hyperinflation 1922-23
(January 1922 =1)
Currency
Prices
Real
Money
Inflation
(% per month)
Jan 1922
1
1
1.00
5
Jan 1923
16
75
0.21
189
July 1923
354
2021
0.18
386
Sept 1923
227777
645946
0.35
2532
20201256
191891890
0.11
29720
Oct 1923
11-25
11-26
Further Examples
A 200,000 and 500,000 German
Mark coin from 1923
 A 500,000,000,000 (500
billion) Yugoslav dinar
banknote circa 1993 the
largest nominal value
ever officially printed in
Yugoslavia.
11-27
Quantity Theory
MV = PY
Velocity: the circulation rate of money
Inflation is always and everywhere monetary phenomenon.
Milton Friedman
11-28
%M + %V = %P + %Y
 Assume V = constant, so %V = 0

%M = %P + %Y
 %Y determined by investment, technology,
etc.

%M is proportional to %P
Seignorage
Growth in
Money
Supply
Inflation
11-29
US Inflation and Money Growth
10
8
1970s
1910s
Inflation %
6
1940s
1980s
4
1990s
2
1960s
1900s
1950s
0
1890s
1880s
1930s
1920s 1870s
-2
-4
0
2
4
6
8
Money Supply Grow th (%)
10
12
11-30
UK Inflation and Money Growth
11-31
Cross-country Inflation and Money
Growth, Long Run
11-32
Cross-country Inflation and Money
Growth, Short Run
11-33
Summary
 Inflation
 Measures
 Costs
 Deflation
 Money
 Definitions
 Multiplier
 Seignorage and Inflation Tax
 Hyperinflation