25 terms

What is the Quantity theory of money?

it links the inflation rate to growth rate of money supply

What is the velocity of money?

The rate at which money circulates or the # of times the average dollar changes hands in a time period

What is the equation of velocity?

V= T/M

V- velocity

T- value of all transactions

M- money supply

V- velocity

T- value of all transactions

M- money supply

What is the equation of velocity using GDP?

V= (P*Y)/M

P*Y= value of output= nominal GDP

P*Y= value of output= nominal GDP

What is the quantity equation of money?

MV=PY

What is the real money balance? equation?

the purchasing power of the money supply

M/P

M/P

What is the money demand?

(M/P)ᵈ= kY

what is the variable k?

1/V

what is the inflation rate symbol?

π

what is the inflation equation?

π=(∆P/P)

what are the 2 implications of quantity theory?

1. countries with higher money growth have higher inflation rates

2. Long-run inflation should be similar to the growth

2. Long-run inflation should be similar to the growth

What is Seigniorage

the "revenue" raised by printing money

What is the inflation tax

the printing of money to raise revenue that causes inflation that your income in the tax bracket

what is the fisher effect?

increase in π = increase in i

What is π? what is Eπ?

π is the actual known interest rate

Eπ is the expected inflation rate

Eπ is the expected inflation rate

what is i-Eπ?

ex ante: the real interest rate people expect at the time of investment

what is i-π?

ex post: the real interest rate actually realized

what is the real money demand equation? explain the variables.

(M/P)ᵈ=L(i,Y)

i= the opportunity cost of holding money

y= is the value of spending on goods and services

i= the opportunity cost of holding money

y= is the value of spending on goods and services

What is the classical view on inflation?

a change in price level is merely a change in the units of measure

What are the 5 expected social costs of inflation? Explain.

1. Shoe-leather Cost: the cost of reducing money balances to avoid the inflation tax

2. Menu Cost: the cost of changing prices

3. Relative Price Distortions: firms facing menu costs change prices infrequently

4. Unfair Tax Treatment: taxes are not adjusted to account for inflation

5. General Inconvenience: harder to compare nominal values from different periods

2. Menu Cost: the cost of changing prices

3. Relative Price Distortions: firms facing menu costs change prices infrequently

4. Unfair Tax Treatment: taxes are not adjusted to account for inflation

5. General Inconvenience: harder to compare nominal values from different periods

What is the unexpected social cost? examples

Arbitrary Redistribution of purchasing power

- contracts based on Eπ not π when Eπ≠π

- contracts based on Eπ not π when Eπ≠π

What happens when π>Eπ?

purchasing power is more variable and unpredictable

What are the benefits of inflation?

nominal wages are reduced

allows real wage to reach equilibrium without nominal wage cuts

allows real wage to reach equilibrium without nominal wage cuts

What is hyperinflation? think money

solutions?

solutions?

money loses its store of value

solution: barter system or foreign currency

solution: barter system or foreign currency

What is Classical Dichotomy?

Real variables: physical output and relative prices

nominal variables: measured in money units

nominal variables: measured in money units