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Money Growth and Inflation
BSC AGRI 2
PAE
UNIT 3
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.
THE CLASSICAL THEORY OF INFLATION
• Inflation is an increase in the overall level of
prices.
• Hyperinflation is an extraordinarily high rate
of inflation.
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.
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.
THE CLASSICAL THEORY OF INFLATION
• 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.
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.
Money Supply, Money Demand, and Monetary
Equilibrium
• Money demand has several determinants,
including interest rates and the average level
of prices in the economy.
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.
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.
THE CLASSICAL THEORY OF
INFLATION
• 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 of money available in the economy
determines the value of money.
• The primary cause of inflation is the growth in the
quantity of money.
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.
Velocity and the Quantity Equation
• It 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.
Velocity and the Quantity Equation
• The Equilibrium Price Level, Inflation Rate, and
the Quantity Theory of Money
– The velocity of money is relatively stable over
time.
– When the Fed changes the quantity of money, it
causes proportionate changes in the nominal
value of output.
– Because money is neutral, money does not affect
output.
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.
The 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.
• The inflation ends when the government
institutes fiscal reforms such as cuts in
government spending.
The Fisher Effect
• The Fisher effect 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.
Figure 5 The Nominal Interest Rate and the Inflation
Rate
Copyright © 2004 South-Western
Percent
(per year)
1960 1965 1970 1975 1980 1985 1990 1995 2000
0
3
6
9
12
15
Inflation
Nominal interest rate
THE COSTS OF INFLATION
• A Fall in Purchasing Power?
– Inflation does not in itself reduce people’s real
purchasing power.
THE COSTS OF INFLATION
• Shoeleather costs
• Menu costs
• Relative price variability
• Tax distortions
• Confusion and inconvenience
• Arbitrary redistribution of wealth
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.
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.
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.
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.
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 hyperinflation.
Source
• 1. Elementary economic theory - K.K. Dewett
and J.D. Verma
• 2. International Economics - B. Mishra
• 3. Fundamentals of Agricultural Economics -
A.N. Sadhu and A. Singh
• 4. Economics - Paul A. Samelson and W.D.
Nordhans (Pearson Publications)

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Bsc agri 2 pae u-3.3 inflation

  • 1. Money Growth and Inflation BSC AGRI 2 PAE UNIT 3
  • 2. 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.
  • 3. THE CLASSICAL THEORY OF INFLATION • Inflation is an increase in the overall level of prices. • Hyperinflation is an extraordinarily high rate of inflation.
  • 4. 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.
  • 5. 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.
  • 6. THE CLASSICAL THEORY OF INFLATION • 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.
  • 7. 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.
  • 8. Money Supply, Money Demand, and Monetary Equilibrium • Money demand has several determinants, including interest rates and the average level of prices in the economy.
  • 9. 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.
  • 10. 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.
  • 11. THE CLASSICAL THEORY OF INFLATION • 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 of money available in the economy determines the value of money. • The primary cause of inflation is the growth in the quantity of money.
  • 12. 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.
  • 13. Velocity and the Quantity Equation • It 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.
  • 14. Velocity and the Quantity Equation • The Equilibrium Price Level, Inflation Rate, and the Quantity Theory of Money – The velocity of money is relatively stable over time. – When the Fed changes the quantity of money, it causes proportionate changes in the nominal value of output. – Because money is neutral, money does not affect output.
  • 15. 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.
  • 16. The 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. • The inflation ends when the government institutes fiscal reforms such as cuts in government spending.
  • 17. The Fisher Effect • The Fisher effect 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.
  • 18. Figure 5 The Nominal Interest Rate and the Inflation Rate Copyright © 2004 South-Western Percent (per year) 1960 1965 1970 1975 1980 1985 1990 1995 2000 0 3 6 9 12 15 Inflation Nominal interest rate
  • 19. THE COSTS OF INFLATION • A Fall in Purchasing Power? – Inflation does not in itself reduce people’s real purchasing power.
  • 20. THE COSTS OF INFLATION • Shoeleather costs • Menu costs • Relative price variability • Tax distortions • Confusion and inconvenience • Arbitrary redistribution of wealth
  • 21. 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.
  • 22. 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.
  • 23. 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.
  • 24. 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.
  • 25. 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.
  • 26. 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 hyperinflation.
  • 27. Source • 1. Elementary economic theory - K.K. Dewett and J.D. Verma • 2. International Economics - B. Mishra • 3. Fundamentals of Agricultural Economics - A.N. Sadhu and A. Singh • 4. Economics - Paul A. Samelson and W.D. Nordhans (Pearson Publications)

Hinweis der Redaktion

  1. Bullet 2: Mankiw has removed the word, “directly”
  2. Align text for second bullet.
  3. The equation of the fisher effect must appear here or on a new next slide: “Nominal interest rate = real interest rate + inflation rate”