C5 Facing the Facts of Increasing Prices: Inflation

Question 1

ur·ban

Answer 1

adjective

1. in, relating to, or characteristic of a town or city.
2. denoting or relating to popular dance music associated with black performers.

Question 2

ru·ral

Answer 2

adjective

in, relating to, or characteristic of the countryside rather than the town.

Question 3

pe·nal

Answer 3

adjective

relating to, used for, or prescribing the punishment of offenders under the legal system.

synonyms:disciplinary, punitive, corrective, correctional

(of an act or offense) punishable by law.

Question 4

the three most commonly used price indices for measuring inflation rates?

Answer 4

Consumer Price Index (CPI)

Producer Price Index (PPI)

GDP Deflator

Question 5

how is the Consumer Price Index (CPI) derived?

Answer 5

measuring the price increase on a “representative basket” of consumer goods and services (excludes firms and goverments) from the buying patterns of residents in the urban or metropolitan areas

CPI_{cost yr} = Basket Cost_{cost yr} / Basket Cost_{base yr}

pg 84

Question 6

what is the Producers Price Index (PPI) meant to capture?

Answer 6

the prices most domestic producers get paid for their output (trade from business-to-business not business-to-consumer) and PPI prices movments will take place a little in advanve of CPI price changes and eventually show up in the prices paid by consumers

Question 7

GDP deflator calculations

Answer 7

Def = 100 _^x Nominal GDP / Real GDP

basically nominal GDP and real GDP are measured first and then the ratio between the two is used to calculate the price index value (Def.) often refered to as the implicit GDP deflator

Question 8

the GDP deflator is a broader measure of inflation than CPI because..?

Answer 8

it captures price pressures for both consumer goods and producer goods

Question 9

nominal interest rates

Answer 9

percentage return in terms of dollars e.g. 5% interest on $10,000 produces $10,500 a year later

Question 10

real interest rates

Answer 10

percentage return in terms of goods (units of GDP) e.g. at a 5% interest rate with 5% inflation you get $0 dollars increase in return on your deposit after 1 year

Question 11

inflation is all about money, specifically…?

Answer 11

how fast money is losing value, the fall in purchasing power

Question 12

velocity of money

Answer 12

The velocity of money is the rate at which money is exchanged in an economy. … The velocity of money is usually measured as a ratio of gross national product (GNP) to a country’s total supply of money.

Question 13

quantity equation?

Answer 13

the relationship between money, how fast it circulates, prices, and income.

Question 14

Y =

P =

PY =

M =

V =

Answer 14

Y = Real GDP

P = price index

PY = Nominal GDP

M = Money (assets in circulation)

V = velocity of money

Question 15

GDP is measured as a flow and money as a stock. If nominal GDP is $18 trillion per year and the money stock is $3 trillion, then what is the velocity?

Answer 15

V = Nominal GDP / Money = PY / M

Velocity is $6 per year

which means the average dollar changes hands once every two months.

Question 16

explain how PY = nominal GDP

Answer 16

real GDP times the price index would equal nomial GDP because the price index was used to convert the nominal GDP to real GDP

Question 17

the definition of price velocity is rewritten as the quanity equation how?

Answer 17

MV = PY

money (stock $3 trillion) times the velocity ($6) equals nominal GDP ($18 trillion)

Question 18

π

Answer 18

symbol of inflation used by economist in equations

not pie

Question 19

the quantity equation tells us the ___ ____ not the growth rates.

Answer 19

price level

Question 20

what does this equation mean where g_x represents the growth rate of variable X?

π = g_m + g_v - g_y

used to convert the quantity equation levels to growth rates

Answer 20

it says that the rate of inflation π is equal to the rate of growth of money plus the growth rate of velocity minus the growth rate of output (GDP).

Question 21

over the long term the increase in the velocity of money is likely the result of…?

Answer 21

technological change in the financial sector (Fintech)

Question 22

if the amount of money in the enconomy (M) increases adn the amount of goods (Y) stays unchanged, what happens?

Answer 22

goods become relatively scarce and money is relatively abundant. This causes the prices of things to increase, because the rate at which you can turn money into goods worsens

Question 23

the quantity equation is useful, especially in its growth form because it makes clear where inflation comes from. Basically inflation happens for one of three reasons: ?

Answer 23

1. Faster money growth, g_m
2. Faster growth in velocity, g_v
3. Slower growth in real GDP, g_y

Question 24

of the three basic factors of inflation what two do the policy makers have little control over in the long run?

Answer 24

Velocity and real GDP growth. These are due to more labor input, technology and more capital. They follow a long term trend controlled by the markets (Adam Smiths invisible hand)

Question 25

policy makers due control one of the three factors of inflation...?

Answer 25

the rate of growth of money

Question 26

inflation is the sum of money ___ \_\_\_\_ and ____ \_\_\_\_ less the growth in ___ \_\_\_\_.

Answer 26

inflation is the sum of **money money** growth and **velocity growth** less the growth in **real GDP.**

Question 27

velocity growth and output growth are essentially given in the long run, so the principal determinate of whether long run inflation is high or low is the...?

Answer 27

Fed's choice of how fast to grow the money supply

Question 28

over time nominal wages (wage in terms of money) tend to keep up with inflation, or even rise faster which is the same as saying real wages (wage in terms of goods)...?

Answer 28

tend to rise over time

Question 29

how does inflation allow policy makers more flexibility with regards to real and nominal wages?

Answer 29

Inflation allows real wage to fall without cutting nominal wages. It makes real wages flexible even though nominal wages are not.

Question 30

if I purchase a piece of real estate and the nominal value will doubles in 35 years and the real inflation rate is 2% during that time period, what will be my net increase in real value?

Answer 30

the net increase in value will be $0 in terms of purchasing power

Question 31

real interest rate equals what?

Answer 31

nominal interest rate minus inflation r = i - Π

Question 32

if I borrow $100,000 at a 5% nominal interest rate over a term of 5 years and the reall inflation rate is 3% over that time period, what is my real interest rate?

Answer 32

2%

Question 33

policy makers cannot set a negative nominal interest rate but they can set a negative real interest rate by..?

Answer 33

setting the nominal interest rate to be less than inflation

Question 34

with no inflation how can policy makers set a negative real interest rate? And what would be the effect?

Answer 34

they can't it is impossible (this would mean putting $100 in the bank and getting back, say $95 and people would just keep their cash under their mattresses)

Question 35

hyper inflation refers to..?

Answer 35

Extremely high inflation. No agreed definition exist of what constitutes it but people experiencing it know it typically by prices of things rising on a daily basis

Question 36

seigniorage seign·ior·age

Answer 36

profit made by a government by issuing currency, especially the difference between the face value of coins and their production costs.

Question 37

closely related to seigniorage is the idea that inflation is a ____ on money. Explain?

Answer 37

tax on money [If you start Monday morning with $10K in your wallet and inflation is 5% per day, Tuesday morning will be like the government took $500 out of your wallet]

Question 38

if a government wasn't running a budget deficit it wouldn't need to borrow money, and if someone were willing to lend it money at a reasonable rate, it wouldn't have to...?

Answer 38

Print money to cover the budget deficit. They usually turn to this as the only remaining option because relying heavily on seigniorage never ends well.

Question 39

inflationary psycology

Answer 39

refers to the fact that when inflation is persistant, and becomes large, people start acting differently in ways that perpetuate the inflation and possible make it worse

Question 40

per·pet·u·ate

Answer 40

verb make (something, typically an undesirable situation or an unfounded belief) continue indefinitely. "the law perpetuated the interests of the ruling class" synonyms:keep alive, keep going, keep in existence,

Question 41

how does the time difference in goverment expenditures and tax collection affect a government in a high inflation enviroment?

Answer 41

by the time the tax dollars come in, they've lost so much purchasing power that the deficit gaps widens even further, which leads to more money growth to cover the difference, which leads to higher inflation. A vicious cycle in motion.

Question 42

i dont understand how money velocity affects inflation page 99

Question 43

deflation

Answer 43

falling in prices

Question 44

effects of deflation

Answer 44

if people expect prices to fall they hang on to their cash and wait to buy. Velocity drops, and prices start to fall as expected

Question 45

commercial banks are required to deposit funds with the central bank for what?

Answer 45

as reserves against their checking deposits. This is the main reason that a central bank can control money growth.

Question 46

in the recent years many central banks have begun to pay a negative interest rate on the reserve deposits of commercial banks. Why?

Answer 46

to incentivize commercial banks to create more credit and loans to households and businesses which will create money growth and avoid deflationary pressures