Download Lecture27(Ch24)

MONEY
• Definition of money
– the part of wealth used to facilitate transactions
• Note that in economics, money has a
different meaning than expressions like:
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“She makes a lot of money”
“We’re cash. We’re cash. We’re money”
“We’re cash. We’re cash. We’re money”
“We’re cash. We’re cash. We’re money”
“We’re cash. We’re cash. We’re money”
• Consider some examples of money
Stone money of Yap Island
Ancient Chinese bronze money
A100 billion mark note!!
German Reichsbank, 1923
Most of money today consists of
deposits at banks
• Money supply = currency + deposits
• M1 = currency plus checking deposits
• M2 = M1 plus time deposits, savings
deposits
• difficult to determine which is the best
measure of money
Three functions of money
• medium of exchange
• store of value
• unit of account
General principle of monetary
economics
• A higher rate of money growth ultimately
causes higher inflation, ceteris paribus
– check intuition with case of commodity money
Quantity equation of money
• MV = PY
• where M = money supply, P = price level,
Y = real GDP, and V = velocity = PY/M
• growth rate form of quantity equation
• money growth + velocity growth
= inflation + real GDP growth
– examples 4 + .5 = 2 + 2.5
– Change 8 + .5 = 6 + 2.5
What is the empirical evidence?
Does the quantity equation of money work?
• Very well for big changes of over long run
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The German hyperinflation,1923 (see graph)
American revolutionary war
Great Inflation of the 1970s (see graph)
Russia, Argentina and Brazil
Take a careful look at the G-7 graph
• Less reliable in the short run
– Difficult to measure money
– Changes in M will affect Y
Inflation in Germany, 1923
24_07
INFLATION RATE
(PERCENT PER WEEK)
300
250
200
150
100
50
0
-50
Jan 6
Mar 7
May 7
Jul 7
Sep 7
Nov 7
24_06
Great
Disinflation
PRICE INDEX
1,000
Deflation
after Civil
War
Fed
created
Great
Depression
Great
Inflation
100
War of 1812
WWI
10
1800
1820
1840
1860
1880
1900
1920
WWII
1940
1960
1980
2000
Money growth and inflation
1973-1991
24_05
MONEY GROWTH
(PERCENT PER YEAR)
18
16
U.K.
14
Italy
12
10
France
Germany
8
Canada
6
United States
4
Japan
2
0
2
4
6
8
10
12
14
INFLATION
(PERCENT PER YEAR)
Long run versus short run effect
of changes in money growth
• Inflation does not usually increase right
away
– takes more than a year
• In the meantime, other things are affected
– employment, production
• Makes money a difficult public policy issue,
– money has long been central in political
debates, as the following video nicely illustrates
When he gets to Washington
how the Democrats will run.
For Republicans
McKinley leads the way.
What a glory that will be.
We’ll regain prosperity,
when McKinley and
protection win the day
We will answer their demands for
a gold standard by saying to them:
You shall not press down
upon the brow of labor
this crown of thorns.
You shall not crucify
mankind on a cross of gold.
Sound the good old bugle
with the bimetallic ring.
Silver free from sea to sea
with lusty voices sing.
Our banner with its silver stars,
the waving breezes fling.
Marching with Bryan to
victory.
Lessons from this piece of
American history
• An economic issue became a great political
issue to run on
• Increasing money growth by coining silver
would be more inflationary than the gold
standard--and people knew it!
• Increase in inflation was attractive to some
Democrats (debtors versus creditors)
• Several years later legislation was passed to
establish a central bank in the United States
The Central Bank
• The agency of government given
responsibility of controlling the money
supply--we will see how next time.
• In the United States, the central bank is the
Federal Reserve System:
– Simply called the Fed
– Has a great degree of independence
• Let’s check it out on the web
24_03
Board of Governors
• Seven governors appointed by
the president and confirmed by
the Senate
• One governor appointed to be
chair
• A staff of professional economists
and statisticians
District Federal Reserve Banks
• Banks located in 12 districts
throughout the country
• Each district bank headed by
a president chosen by commercial bankers and others in
the district but approved by
the Board of Governors
Federal Open Market Committee (FOMC)
• Makes decisions about the money supply
and the federal funds interest rate
• Consists of the Board of Governors and
district bank presidents (only five
presidents vote at a time)
• Meets about eight times per year in
Washington plus telephone conferences
when needed
24_02
32-3
1
9
Minneapolis
2
7
New York
3
12
Chicago
San Francisco
Cleveland
10
Kansas City
4
Richmond
St. Louis
5
8
Dallas
11
Boston
Atlanta
6
Philadelphia
Federal
Reserve Board,
Washington, D.C.
END
OF
LECTURE