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Chapter 30: Money Growth and Inflation (REVIEW), Chapter 30: Money Growth and Inflation
Terms in this set (71)
What can Inflation be measured by?
percentage change in the consumer price index
What do most economist today rely on to explain the long-run determinants of the price level and the inflation rate?
quantity theory of money
What happens to the number of dollars needed to buy a representative basket of goods, when the price level falls?
Decreases, so the value of money falls.
What way is the money supply curve when the value of money is on the vertical axis?
Vertical because we assume the central bank controls the money supply.
When does the supply of money increase?
Fed makes open-market purchases
What does money demand depend on?
the price level and the interest rate
What does the value of money do when price levels rise?
decreases, so people want to hold more of it
What does quantity of money do when price levels decrease? Money market is drawn with the value of money on the vertical axis.
What happens to the equilibrium value of money when money supply is increased? Money market is drawn with value of money on the vertical axis.
decreases, while the equilibrium quantity of money increases.
How did the central banks in many countries increase their money supply in the 1970s, in response to recessions caused by an increase in the price of oil?
purchasing bonds on the open market, which would have lowered the value of money.
What will happen to the money supply curve when the Federal Reserve sells bonds? Money market is drawn with the value of money on the vertical axis.
Shifts leftward, causing the value of money measured in terms of goods and services to rise.
What will happen if the money supply increases by 5% according to the assumptions of the quantity theory of money?
the price level would rise by 5% and real GDP would be unchanged
What does a 3% increase in the money supply do, according to the quantity theory of money?
causes the price level to rise by 3%
What is Inflation tax?
the revenue a government creates by printing money
What is shoe leather cost?
the resources wasted when inflation encourages people to reduce their money holdings
What is the sacrifice of time and convenience, for people go to the bank more frequently to reduce currency holdings when inflation is high referred to as?
Shoe leather cost
What is menu costs, and what are some examples?
The costs of changing prices.
Ex. deciding on new prices, printing new price lists, advertising new prices
For a given real interest rate, what does an increase in inflation do to the after-tax real interest rate?
decreases, which discourages savings
What is inflation when wealth is redistributed from debtors to creditors.
What happens when inflation is higher than expected?
creditors receive a lower real interest rate than they have anticipated
What must the central bank do in order to maintain stable prices?
tightly control the money supply
What is store Value?
an item that people use to transfer purchasing power from the present to the future.
What are real variables?
Variables measured in physical units
What is the velocity of money?
the rate at which money changes hands
What is the quantity equation?
M x V = P xY
relates the quantity of money to the nominal value of output (nominal GDP)
What is the Fisher effect?
the one-for-one adjustment of the nominal interest rate to the inflation rate.
nominal interest rate = inflation rate + real interest rate
What is wealth?
refers to the total of all stores of value, including both money and nonmonetaty assets like stocks and bond.
determines how much of our wealth we allocate in the form of money versus other non-monetary assets in the classical model of inflation
What is the Equilibrium?
a situation in which the market price (value of money) has reached the level at which the quantity (of money) demanded equals the quantity (of money) supplied
In what ways can the Government obtain funds?
taxes, issue bonds, Print money
why is the money supply curve vertical?
because the Fed has fixed the quantity of money available
What causes the money supply curve to shift?
Change in supply of money.
Why is the money demand curve downward sloping?
indicating that when the value of money is low (and the price level is high), people demand a larger quantity of it to buy goods and services.
What does the equilibrium of money supply and money demand determine?
the value of money and the price level
What is P?
P is the price level -- the price of a basket of goods, measured in money
What is 1/P?
1/P is the value of $1, measured in goods
What does inflation do to prices and the value of money?
Inflation drives up prices and drives down the value of money
Who developed the quantity theory of money?
Who advocated the quantity theory of money?
Who controls the money supply?
What does money demand refer to?
How much wealth people want to hold in liquid form
How is the demand of money related to the value of money and P?
Quantity of money demanded is negatively related to the value of money and positively related to P
What happens to P and the value of money when the FED increases the money supply?
The value of money falls and P rises
What are the axes on the money supply-demand diagram?
Y-axis: 1/P (the value of money)
X-axis: Quantity of money
What are nominal variables?
Variables measured in monetary units
Are prices nominal or real variables?
What is a relative price?
The price of one good relative to (divided by) another
Are relative prices nominal or real variables?
What is the classical dichotomy?
The theoretical separation of nominal and real variables
Hume and the classical economists suggested that monetary developments affect ____ variables, but not ____ variables.
affect nominal variables, but not real variables.
If the central bank doubles the money supply, what happens to nominal and real variables?
All nominal variables will double
All real variables will remain unchanged
What is monetary neutrality?
The proposition that changes in the money supply do not affect real variables
If the money supply is doubled, what is the effect on relative prices?
Relative prices are unchanged
If the money supply is doubled, what is the effect on the real wage?
The real wage is unchanged
If the money supply is doubled, what is the effect on output?
Total output is unchanged
Do the classical dichotomy and neutrality of money describe the economy in the short run or long run?
What is the velocity of money?
The rate at which money changes hands
What is the formula for the velocity of money?
V = (P x Y)/M
What does the numerator in the velocity formula represent?
What is the quantity equation?
M x V = P x Y
A change in M in the quantity equation causes what to change?
A change in M causes nominal GDP & P to change by the same percentage.
Rapid money supply growth growth causes what?
If real GDP is constant, what is the relationship between the inflation rate and money growth rate?
Inflation rate equals money growth rate
If real GDP is growing, what is the relationship between the inflation rate and money growth rate?
Inflation rate is less than Money growth rate
What is hyperinflation?
Inflation exceeding 50% per month.
What percentage of total revenue in the US does the inflation tax account for?
Less than 3%
Where is the real interest rate determined?
By saving and investment in the loanable funds market
What is the inflation fallacy?
Most people believe inflation erodes real incomes but inflation affects prices and wages. In the long run, real incomes are determined by real variables, not the inflation rate
How does inflation cause the misallocation of resources from relative-price variability?
Firms don't all raise prices at the same time, so relative prices can vary, distorting the allocation of resources
How does inflation cause tax distortions?
Inflation makes nominal income grow faster than real income --> taxes based on nominal income--> causes people to pay more taxes even when their real incomes don't increase.
How does inflations cause arbitrary redistributions of wealth?
Higher-than-expected inflation transfers purchasing power from creditors to debtors: Debtors get to repay their debt with dollars that aren't worth as much.
Lower-than-expected inflation transfers purchasing power from debtors to creditors.
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