Chapter 7 Flashcards
(22 cards)
The only way consumers can spend money on all goods
is an increase in the money supply.
The equation of exchange shows
the relationship between prices and the money supply.
MV=PQ, where
M is the money supply,P is the price level, and Q is the amount produced by the economy.
In the equation of exchange, V
stands for velocity, or how much the money supply must turnover to purchase an output.
The interpretation of the equation of exchange is
that money(M) buys output in the economy(P), which is spent and respent at the rate of velocity (V).
The simple quantity theory adds the observations that
1)Over a short period of time, resources are limited, so output is limited and 2)The speed at which money moves through the economy is limited.
The result of the simple quantity theory is
that the price level and money supply are proportional.
What is the simple answer to “where does inflation come from?”
The Fed and banking system increasing the money supply.
In the monetarist theory,
Velocity is not fixed, but is constant, and production is not limited as it is always moving forward.
In Friedman’s Helicopter story, we learn that,
In the long run, real prices are the same as before, but with inflation.
Inflation is spread evenly over all goods and
does not effect production decisions.
With unanticipated inflation,
borrows gain and lenders lose, as well as saver’s losing money
The nominal interest rate is
the interest rate that banks advertise.
The real interest rate is
what the banks calculate the interest rate to be, after inflation.
Secure loans
have asset backing.
Unsecured loans
have nothing backing the loan (Credit card loans),
As long as prices rise and fall by the same amount and inflation is anticipated,
inflation has no effect on the economy.
With uneven inflation,
consumers don’t know the real prices of goods.
Inflation not only causes uneven prices, but it
can also cause a bubble that inflates prices in a specific part of the market,
If a central bank attempts to assist the state by purchasing debt in return for dollars, we say that the state is
monetizing the debt.
Monetizing the debt causes inflation, but
inflation assists the state in financing its borrowing.
When the state creates debt to lower its inflationary tax,
this is the inflationary tax.
