Download money supply

Chapter 30
Money Growth
and Inflation
The Meaning of Money
• Money is the set of assets in an economy
that people regularly use to buy goods and
services from other people.
30.1 The Classical Theory of Inflation
• Inflation is an increase in the overall level
of prices.
• Hyperinflation is an extraordinarily high
rate of inflation.
30.1 The Classical Theory of Inflation
• Inflation: Historical Aspects
– Over the past 60 years, prices have risen on
average about 5 percent per year.
– Deflation, meaning decreasing average prices,
occurred in the U.S. in the nineteenth century.
– Hyperinflation refers to high rates of inflation
such as Germany experienced in the 1920s.
30.1 The Classical Theory of Inflation
• Inflation: Historical Aspects
– In the 1970s prices rose by 7 percent per year.
– During the 1990s, prices rose at an average rate
of 2 percent per year.
30.1.1 The Level of Prices and the Value
of Money
• It may help to express these ideas mathematically.
Suppose P is the price level as measured by the
consumer price index or the GDP deflator. Then P
measures the number of dollars needed to buy a
basket of goods and services. Now turn this idea
around: The quantity of goods and services that
can be bought with $1 equals 1/P. In other words,
if P is the price of goods and services measured in
terms of money, 1/P is the value of money
measured in terms of goods and services. Thus,
when the overall price level rises, the value of
money falls.
30.1.1 The Level of Prices and the
Value of Money
• The quantity theory of money is used to explain
the long-run determinants of the price level and
the inflation rate.
• Inflation is an economy-wide phenomenon that
concerns the value of the economy’s medium of
exchange.
• When the overall price level rises, the value of
money falls.
30.1.2 Money Supply, Money Demand,
and Monetary Equilibrium
• The money supply is a policy variable that is
controlled by the Fed.
– Through instruments such as open-market
operations, the Fed directly controls the
quantity of money supplied.
30.1.2 Money Supply, Money
Demand, and Monetary Equilibrium
• Money demand has several determinants,
including interest rates and the average
level of prices in the economy.
30.1.2 Money Supply, Money
Demand, and Monetary Equilibrium
• People hold money because it is the medium of
exchange.
– The amount of money people choose to hold
depends on the prices of goods and services.
30.1.2 Money Supply, Money
Demand, and Monetary Equilibrium
• In the long run, the overall level of prices
adjusts to the level at which the demand for
money equals the supply.
Figure 1 Money Supply, Money Demand, and
the Equilibrium Price Level
Value of
Money, 1/P
(High)
Price
Level, P
Money supply
1
1
3
1.33
/4
12
/
Equilibrium
value of
money
(Low)
A
(Low)
2
Equilibrium
price level
14
4
/
Money
demand
0
Quantity fixed
by the Fed
Quantity of
Money
(High)
Figure 2 The Effects of Monetary Injection
Value of
Money, 1/P
(High)
MS1
MS2
1
1
1. An increase
in the money
supply . . .
3
2. . . . decreases
the value of
money. . .
Price
Level, P
/4
12
/
A
/
1.33
2
B
14
(Low)
3. . . . and
increases
the price
level.
4
Money
demand
(High)
(Low)
0
M1
M2
Quantity of
Money
30.1.4 The Effects of a Monetary Injection
• The Quantity Theory of Money
– How the price level is determined and why it
might change over time is called the quantity
theory of money.
– The Quantity Theory of Money is a theory
asserting that the quantity of money available
in the economy determines the price level (or
the value of money) and that the growth in the
quantity of money available determines the
inflation rate.
30.1.5 The Classical Dichotomy and
Monetary Neutrality
• Nominal variables are variables measured in
monetary units.
• Real variables are variables measured in
physical units.
• the classical dichotomy is the theoretical
separation of nominal and real variables.
30.1.5 The Classical Dichotomy
and Monetary Neutrality
• According to Hume and others, real economic
variables do not change with changes in the
money supply.
– According to the classical dichotomy,
different forces influence real and nominal
variables.
• Changes in the money supply affect nominal
variables but not real variables.
30.1.5 The Classical Dichotomy
and Monetary Neutrality
• The irrelevance of monetary changes for real
variables is called monetary neutrality货币中性.
30.1.6 Velocity and the Quantity
Equation
• The velocity of money refers to the speed at
which the typical dollar bill travels around the
economy from wallet to wallet.
30.1.6 Velocity and the Quantity
Equation
V = (P  Y)/M
– Where: V = velocity
P = the price level
Y = the quantity of output
M = the quantity of money
30.1.6 Velocity and the Quantity
Equation
• Rewriting the equation gives the quantity
equation:
MV=PY
30.1.6 Velocity and the Quantity
Equation
• The quantity equation relates the quantity of
money (M) to the nominal value of output
(P  Y).
30.1.6 Velocity and the Quantity
Equation
• The quantity equation shows that an increase in
the quantity of money in an economy must be
reflected in one of three other variables:
– the price level must rise,
– the quantity of output must rise, or
– the velocity of money must fall.
Figure 3 Nominal GDP, the Quantity of Money,
and the Velocity of Money
Indexes
(1960 = 100)
2,000
Nominal GDP
1,500
M2
1,000
500
Velocity
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
30.1.6 Velocity and the Quantity Equation
Explain the Equilibrium Price Level and Inflation
Rate? (What is 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
proportional changes in the nominal value of
output (P  Y).
3. The economy’s output of goods and services(Y) is
primarily determined by factor supplies (labor,
physical capital, human capital, and natural
resources) and the available production technology.
In particular, because money is neutral, money
does not affect output.
4. With output(Y) determined by factor supplies and
technology, when the central bank alters the money
supply (M) and induces proportional changes in the
nominal value of output (P  Y), these changes are
reflected in changes in the price level (P).
5. Therefore, when the central bank increases the
money supply rapidly, the result is a high rate of
inflation.
CASE STUDY: Money and Prices
during Four Hyperinflations
• Hyperinflation is inflation that exceeds 50
percent per month.
• Hyperinflation occurs in some countries
because the government prints too much
money to pay for its spending.
Figure 4 Money and Prices During Four
Hyperinflations
(a) Austria
(b) Hungary
Index
(Jan. 1921 = 100)
Index
(July 1921 = 100)
100,000
100,000
Price level
Price level
10,000
10,000
Money supply
1,000
100
Money supply
1,000
1921
1922
1923
1924
1925
100
1921
1922
1923
1924
1925
Figure 4 Money and Prices During Four
Hyperinflations
(c) Germany
(d) Poland
Index
(Jan. 1921 = 100)
100,000,000,000,000
1,000,000,000,000
10,000,000,000
100,000,000
1,000,000
10,000
100
1
Index
(Jan. 1921 = 100)
10,000,000
Price level
Money
supply
Price level
1,000,000
Money
supply
100,000
10,000
1,000
1921
1922
1923
1924
1925
100
1921
1922
1923
1924
1925
30.1.7 The Inflation Tax
• When the government raises revenue by printing
money, it is said to levy an inflation tax.
• When the government prints money, the price
level rises, and the dollars in your wallet are less
valuable. Thus, an inflation tax is like a tax on
everyone who holds money.
• The inflation ends when the government institutes
fiscal reforms such as cuts in government
spending.
30.1.8 The Fisher Effect
• Real interest rate = Nominal interest rate
– Inflation rate.
• Nominal interest rate = Real interest rate
+ Inflation rate.
30.1.8 The Fisher Effect
• The Fisher effect 费雪效应 refers to a one-to-one
adjustment of the nominal interest rate to the
inflation rate.
• According to the Fisher effect, when the rate of
inflation rises, the nominal interest rate rises by the
same amount. The real interest rate stays the same.
• Keep in mind that our analysis of the Fisher effect
has maintained a long-run perspective. The Fisher
effect does not hold in the short run to the extent
that inflation is unanticipated.
Figure 5 The Nominal Interest Rate and the
Inflation Rate
Percent
(per year)
15
12
Nominal interest rate
9
6
Inflation
3
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
30.2
The Costs of Inflation
30.2.1 A Fall in Purchasing Power? The
Inflation Fallacy
• If you ask the typical person why inflation is bad,
he will tell you that the answer is obvious:
Inflation robs him of the purchasing power of
his hard-earned dollars. When prices rise, each
dollar of income buys fewer goods and services.
Thus, it might seem that inflation directly lowers
living standards.
30.2.1 A Fall in Purchasing Power? The
Inflation Fallacy
• Yet further thought reveals a fallacy in this answer.
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, inflation
in incomes goes hand in hand with inflation in
prices. Thus, Inflation does not in itself reduce
people’s real purchasing power.
• People believe the inflation fallacy because they do
not appreciate the principle of monetary neutrality.
30.2 The Costs of Inflation
 If nominal incomes tend to keep pace with rising
prices, why then is inflation a problem?…..
Instead, economists have identified several costs
of inflation.
• Shoeleather costs
• Menu costs
• Relative price variability
• Tax distortions
• Confusion and inconvenience
• Arbitrary redistribution of wealth
30.2.2 Shoeleather Costs
• Shoeleather costs are the resources wasted
when inflation encourages people to reduce
their money holdings.
• Inflation reduces the real value of money, so
people have an incentive to minimize their cash
holdings.
30.2.2 Shoeleather Costs
• Less cash requires more frequent trips to the bank
to withdraw money from interest-bearing
accounts.
• The actual cost of reducing your money holdings
is the time and convenience you must sacrifice
to keep less money on hand.
• Also, extra trips to the bank take time away from
productive activities.
30.2.3 Menu Costs
• Menu costs are the costs of adjusting prices.
• 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.
30.2.4 Relative-Price Variability and the
Misallocation of Resources
• Market economies rely on relative prices to
allocate scarce resources. Consumers decide what
to buy by comparing the quality and prices of
various goods and services. Through these
decisions, they determine how the scarce factors of
production are allocated among industries and
firms.
• When inflation distorts relative prices. Consumer
decisions are distorted, and markets are less able
to allocate resources to their best use.
30.2.5 Inflation-Induced Tax Distortion
• Almost all taxes distort incentives, cause people to alter
their behavior, and lead to a less efficient allocation of the
economy’s resources.
• One example of how inflation discourages saving is the tax
treatment of capital gains----the profits made by selling an
asset for more than its purchase price. Suppose that in 1980
you used some of your savings to buy stock in Microsoft
Corporation for $10 and that in 2006 you sold the stock for
$50. According to the tax law, you have earned a capital
gain of $40, which you must include in your income when
computing how much income tax you owe. But suppose the
overall price level doubled from 1980 to 2006. In this case,
the $10 you invested in 1980 is equivalent to $20 in 2006.
When you sell your stock for $50, you have a real gain of
only $30. The tax code, however, does not take account for
inflation and assesses you a tax on a gain of $40.
30.2.5 Inflation-Induced Tax Distortion
• Inflation exaggerates the size of capital gains
and increases the tax burden on this type of
income.
• With progressive taxation, capital gains are taxed
more heavily.
30.2.5 Inflation-Induced Tax Distortion
• The income tax treats the nominal interest
earned on savings as income, even though
part of the nominal interest rate merely
compensates for inflation.
• The after-tax real interest rate falls, making
saving less attractive.
Table 1 How Inflation Raises the Tax Burden on
Saving
30.2.6 Confusion and Inconvenience
• When the Fed increases the money supply
and creates inflation, it erodes the real value
of the unit of account.
• Inflation causes dollars at different times to
have different real values.
• Therefore, with rising prices, it is more
difficult to compare real revenues, costs,
and profits over time.
30.2.7 A Special Cost of Unexpected Inflation:
Arbitrary Redistribution of Wealth
• Unexpected inflation redistributes wealth among
the population in a way that has nothing to do
with either merit or need.
• These redistributions occur because many loans
in the economy are specified in terms of the unit
of account—money.
• Unexpected changes in prices redistribute
wealth among debtors and creditors.
30.2.7 A Special Cost of Unexpected Inflation:
Arbitrary Redistribution of Wealth
• Consider an example. Suppose that Sam student takes
out a $20,000 loan at a 7 percent interest rate from
Bigbank to attend college. In ten years, the loan will
come due. After his debt has compounded for ten years
at 7 percent, Sam will owe Bigbank $40,000. The real
value of this debt will depend on inflation over the
decade. If Sam is lucky, the economy will have a
hyperinflation. In this case, wages and prices will rise so
high that Sam will be able to pay the $40,000 debt out of
pocket change. By contrast, if the economy goes through
a major deflation, the wages and prices will fall, and
Sam will find the $40,000 debt a greater burden than he
anticipated.
Summary
• The overall level of prices in an economy
adjusts to bring money supply and money
demand into balance.
• When the central bank increases the supply of
money, it causes the price level to rise.
• Persistent growth in the quantity of money
supplied leads to continuing inflation.
Summary
• The principle of money neutrality asserts that
changes in the quantity of money influence
nominal variables but not real variables.
• A government can pay for its spending simply
by printing more money.
• This can result in an “inflation tax” and
hyperinflation.
Summary
• According to the Fisher effect, when the inflation
rate rises, the nominal interest rate rises by the
same amount, and the real interest rate stays the
same.
• Many people think that inflation makes them
poorer because it raises the cost of what they buy.
• This view is a fallacy because inflation also
raises nominal incomes.
Summary
• Economists have identified six costs of inflation:
– Shoeleather costs
– Menu costs
– Increased variability of relative prices
– Unintended tax liability changes
– Confusion and inconvenience
– Arbitrary redistributions of wealth
Summary
• When banks loan out their deposits, they
increase the quantity of money in the economy.
• Because the Fed cannot control the amount
bankers choose to lend or the amount households
choose to deposit in banks, the Fed’s control of
the money supply is imperfect.
1. What is the classical Dichotomy and Monetary
neutrality?
2. What is the essence of the quantity theory of
money? (Mankiw,3rd edition,p654.)
3. What is inflation tax? (the revenue the government
raises by creating money)
4.What is the Fisher effect? (the one-for-one
adjustment of the nominal interest rate to the
inflation rate.)
5. List and describe six costs of inflation?
1．解释物价水平上升如何影响货币的实际价值。
2．根据货币数量论，货币量增加的影响是什么？
3．解释名义变量与实际变量之间的差别，并各举出两个
例子。根据货币中性原理，哪一个变量受货币量变动
的影响？
4．从什么意义上说，通货膨胀像一种税？把通货膨胀作
为一种税如何有助于解释超速通货膨胀？
5．根据费雪效应，通货膨胀率的上升如何影响实际利率
与名义利率？
6．通货膨胀的成本是什么？你认为这些成本中的哪一种
对美国经济最重要？
7．如果通货膨胀比预期的低，谁会受益－－债务人还是
债权人？试解释之。