* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download Value of Money
Survey
Document related concepts
Business cycle wikipedia , lookup
Full employment wikipedia , lookup
Virtual economy wikipedia , lookup
Modern Monetary Theory wikipedia , lookup
Quantitative easing wikipedia , lookup
Early 1980s recession wikipedia , lookup
Phillips curve wikipedia , lookup
Long Depression wikipedia , lookup
Monetary policy wikipedia , lookup
Interest rate wikipedia , lookup
Real bills doctrine wikipedia , lookup
Helicopter money wikipedia , lookup
Inflation targeting wikipedia , lookup
Nominal rigidity wikipedia , lookup
Hyperinflation wikipedia , lookup
Transcript
Mid-Term February 15 • • • • MC in-class 30 questions, 3.3 marks each Plus 1 free mark!! Covers chapters 5-11. Principles of Macroeconomics: Unemployment-US data LF = 157 million • 1st 3 months of 2010 • 311,000 jobs lost-NET • • • • • • • Gross flows are huge-dynamic effects ∑ job losses= 6,421,000 jl ∑ job gains = 6,110,000 jg These flows are always large. U declines when jg>jl and VV Jl >>1,190,000 closed, 5,231,000 reduced E Jg>>1,114,000 new, 4,996,000 expansions Overview--11 • The causes of inflation • Money supply, demand and equilibrium • The effects of monetary growth • The quantity theory of money • The inflation tax • The costs of inflation Inflation: Its Causes and Costs • Inflation is a sustained increase in the price level. It is a continuous increase versus a “once-and-for-all” increase in prices. • Inflation deals with the increase in the average of prices and not just significant increases in the price of a few goods. Principles of Macroeconomics: Inflation: Historical Aspects • Over the past sixty years, prices have risen on average about 4 percent per year. • Deflation, a situation of decreasing prices, occurred in the nineteenth century. • In the 1970’s prices rose by 7 percent per year. Doubles in 10 yrs. • From 1990 to 2007 prices rose about 2 percent per year. Principles of Macroeconomics: Inflation: Historical Aspects • Over the past sixty years, prices have risen on average about 4 percent per year. • Deflation, a situation of decreasing prices, occurred in the nineteenth century. • In the 1970’s prices rose by 7 percent per year. Doubles in 10 yrs. • From 1990 to 2007 prices rose about 2 percent per year. Double in 35 Principles of Macroeconomics: The Value of Money • P = the price level (e.g., the CPI or GDP deflator) P is the price of a basket of goods, measured in money. • 1/P is the value of $1, measured in goods. • Example: basket contains one candy bar. • If P = $2, value of $1 is 1/2 candy bar • If P = $3, value of $1 is 1/3 candy bar • Inflation drives up prices, and drives down the value of money. The Causes of Inflation • Inflation is an economy-wide monetary phenomenon that concerns, first and foremost, the value of an economy’s medium of exchange. • To understand the cause of inflation as a monetary phenomenon we must understand the concepts of Money Supply, Money Demand, and Monetary Equilibrium. Principles of Macroeconomics: Money Supply and Money Demand • Money Supply is determined by the Bank of Canada. Through instruments such as open market operations, the B of C directly controls MS • Money Demand by the public has several determinants including: • interest rates and prices in the economy Principles of Macroeconomics: Money Supply and Money Demand • People hold money because it is the medium of exchange. The amount of money people choose to hold depends on incomes and the prices of the goods and services. • In the long-run, the overall level of prices adjusts to the level at which the demand for money equals the supply. Principles of Macroeconomics: Money and Prices (Price axis reversed) Value of Money Money Supply Equilibrium Price Level Equilibrium Value of Money Money Demand Qfixed by B of C Principles of Macroeconomics: Price Level Monetary Equilibrium • The B of C could inject money (monetary injection) into the economy by buying government bonds. Results would be: • The M supply curve shifting to the right • The equilibrium value of money decreasing • The equilibrium price level increasing • This process is referred to as the quantity theory of money. Principles of Macroeconomics: 2 items • Value of M = 1/P • 1/P is the value of $1, measured in goods. • In the diagram, the price (right side) axis is reversed. The HIGH price level is at the bottom and LOW at the top. Monetary Injection Value of Money (High) MS1 Price Level (Low) PE VME Money Demand Low QFixed Principles of Macroeconomics: High Monetary Injection Value of Money (High) MS1 MS2 PE VME VME Money Demand Low QFixed Principles of Macroeconomics: Price Level (Low) PE High Cause of Inflation: The Quantity Theory of Money • The quantity of money available in the economy determines the value of money. Growth in the quantity of money is the primary cause of inflation. • Some macroeconomic variables are unchanged, given changes in the supply of money. Principles of Macroeconomics: Real vs. Nominal Variables • Nominal variables are measured in monetary units. examples: nominal GDP, nominal interest rate (rate of return measured in $) nominal wage ($ per hour worked) • Real variables are measured in physical units. examples: real GDP, real interest rate real wage (measured in output) Real vs Nominal Wage An important relative price is the real wage: W = nominal wage = price of labour, e.g., $15/hour P = price level = price of g&s, e.g., $5/unit of output Real wage is the price of labour relative to the price of output: • W/P = $15/$5 per unit = 3 units of output/hr. Real and nominal • For GDP, can real GDP ever go up faster than nominal GDP?? Real-nominal • If pdot>0, real GDP can’t grow faster than nominal. BUT •R P N • 100 1 100 • 110 0.5 55 • This is DEFLATION Neutrality of Money • Monetary neutrality: changes in the money supply do not affect real variables in the long run. “Pure inflation” • The real wage W/P remains unchanged, so • quantity of labour supplied and demanded don’t change so total employment of labour does not change • The same applies to employment of capital and other resources. • Since employment of all resources is unchanged, total output is also unchanged by the money supply. Monetary Neutrality An increase in the rate of money growth increases inflation but does not affect any “real” variables (e.g. production, employment, real wages, and real interest rates.) Such LR irrelevance of monetary changes for “real” variables is called monetary neutrality. Principles of Macroeconomics: Velocity and The Quantity Equation • “How many times per year is the typical dollar bill used to pay for a newly produced good or service?” • The velocity of money refers to the speed at which the typical dollar bill travels around the economy from wallet to wallet. Principles of Macroeconomics: Velocity and The Quantity Equation V = (P x Y) ÷ M Where: V = Velocity P = The average price level Y = real output-GDP M = the quantity of money • Rewriting the equation gives the quantity equation. MxV=PxY Principles of Macroeconomics: Quantity Theory •M x V = P x Y • RHS is $ value of GDP purchased • LHS is amount of money spent to buy GDP • RHS must equal LHS. • Equation that must hold Five Step Foundation to The Quantity Theory of Money The velocity of money is relatively stable over time. A proportionate change in the nominal value of output is related to changes in the quantity of money by the B of C. Because money is neutral, money does not affect output. Principles of Macroeconomics: Five Step Foundation to The Quantity Theory of Money Changes in the money supply which induce parallel changes in the nominal value of output are also reflected in changes in the price level. When the B of C increases the money supply rapidly, the result is a high rate of inflation. Principles of Macroeconomics: Quantity theory and inflation •MxV=PxY • Assume V constant and Y (real GDP) constant • 2M x V = 2P x Y • Inflations are based on ∆M---the MS • Printing money can’t make you rich. Nominal GDP, M2 and V Hyperinflation & Inflation Tax • Hyperinflation is inflation that exceeds 50 percent per month. • Hyperinflation is caused by the government printing too much money to pay for their spending. Principles of Macroeconomics: Inflation Tax • Deficit if G>T • Usually G borrows to cover deficit • If no lenders have central bank print money • Gov’t pays for things (G) with new money • Gov’t controls central bank Hyperinflation & Inflation Tax • When the government raises revenue by printing money, it is said to levy an inflation tax. An inflation tax is like a tax on everyone who holds money. • Tax on money because value of M falls when lots more is supplied. • The inflation ends when the government institutes fiscal reforms such as cuts in government spending. Principles of Macroeconomics: Hyperinflation • Country end price • Germany 1.02*1010 Monthly pdot 50 • August 1922-November 1923 • Hungary I 44 50 • March 1923 to Feb 1924 • Russia 1.24*105 • December 1921 to January 1924 57 Hungary again • Country end price Monthly pdot • Hungary II 3.81*1027 19,800 • July 1945 to July 1946 • Prices at worst doubled every 12 hours. • Incentives-money is hot potato. Spending fast is critical-work less. 4 Hyperinflations Zimbabwe-2008 • Beginning of July 2008, official figures of inflation rate at 355,000 percent. Some independent estimates as high as 8,500,000 percent. On July 4, 2008, a bottle of beer cost 100 billion Zimbabwean dollars, but an hour later, the price had gone up to $150 billion • printing presses were running out of paper to print the money. Contracted to China • Finally-use of US$, Rand-No Z money. Inflation causes ZWD to fall---US$ to rise Relationship Between Money, Inflation and Interest Rates • Nominal Interest Rate = Real Interest Rate + Inflation Rate • Over the long run, a change in money growth should not affect the Real Interest Rate thus, the Nominal Interest Rate must adjust one-for-one to changes in the Inflation Rate. Principles of Macroeconomics: Relationship Between Money, Inflation and Interest Rates • When the B of C increases the rate of money growth, the result is both a high inflation rate and a higher nominal interest rate. This is called the, Fisher Effect Principles of Macroeconomics: Fisher Effect • i = r + pdot • Nominal = real + inflation • “loose money”--- very expansionary causes high i • “tight money”--monetary policy has lower i Fisher effect The Costs of Inflation • At least six costs of inflation are identified as: 1. 2. 3. 4. 5. 6. Shoeleather costs Menu Costs More variability of relative prices Tax liabilities Confusion and inconvenience Arbitrary redistribution of wealth Principles of Macroeconomics: The Costs of Inflation: Shoeleather Costs • Inflation reduces the real value of money, so people have an incentive to minimize their cash holdings. Less cash requires people to make frequent trips to the bank because they keep their money in interest bearing accounts. • Extra trips to the bank takes time away from productive activities. Principles of Macroeconomics: The Costs of Inflation: Menu Costs • During inflationary times, it is necessary to update price lists and other posted prices. • This is a resource-consuming process that takes away from other productive activities. Principles of Macroeconomics: The Costs of Inflation: Increased Variability of Relative Prices • During times of rising prices, there will be a delay between price increases. While these prices are constant, other prices will be rising. It then becomes difficult to know exact relative prices as prices change irregularly. Px/Py Principles of Macroeconomics: The Costs of Inflation: Unintended Changes in Tax Liability • With inflation, unadjusted incomes are treated as real gains. Consequently, with progressive taxation, rising nominal incomes are taxed more heavily. Principles of Macroeconomics: The Costs of Inflation: Confusion and Inconvenience • With rising prices, it is necessary to constantly make corrections in order to compare real revenues, costs, and profits over time. The time spent making these adjustments could have been spent producing more goods and services. Principles of Macroeconomics: The Costs of Inflation: Arbitrary Redistribution of Wealth • With unanticipated or incorrectly anticipated inflation, wealth is redistributed between net monetary debtors and creditors. This may result in wealth transfers that would not otherwise be acceptable. Principles of Macroeconomics: The Inflation Fallacy • Fallacy: “Inflation reduces individuals’ incomes and causes living standards to decline.” • Fact: “One person’s inflated price is another’s inflated income.” Unless incomes are fixed in nominal terms, the higher prices paid by consumers are exactly offset by the higher incomes received by sellers. Principles of Macroeconomics: CONCLUSION • Prices rise when the govt prints too much money. 10 Principles • Money neutral in the long run, affecting only nominal variables but in the SR has important effects on real variables like output and employment. Conclusion • To explain inflation in the long run, economists use the quantity theory of money. • The LR neutrality of money is the idea that changes in the money supply affect nominal variables, but not real ones. • Inflation tax is the loss in the real value of people’s money when the government causes inflation. Conclusion • The Fisher effect is the one-for-one relation between changes in the inflation rate and changes in the nominal interest rate. • The costs of inflation include menu costs, shoeleather costs, confusion and inconvenience, distortions in relative prices and the allocation of resources, tax distortions, and arbitrary redistributions of wealth.