Chapter 7 Notes Flashcards
(43 cards)
Where does inflation come from?
Inflation is a result of the Fed and the banking system increasing the money supply
How can all consumers spend more money on all goods and services, without reducing their nominal savings?
The money supply must have increased
What is the formula for the equation of exchange?
MV=PQ
What does V stand for in the equation of exchange? Define it.
Velocity is the average number of times a dollar changes hands in a year.
What is the common sense interpretation of the equation of exchange?
A year’s worth of output in the economy is bought by the money supply, which is spent and re-spent V times per year
Where does inflation come from?
Inflation is a result of the Fed and the banking system increasing the money supply
Which assumptions does the simple quantity theory rest on?
The equation of exchange applies. Velocity is constant. Output is constant.
What is the prediction of the simple quantity theory?
The price level and the money supply are proportionally related.
Who founded the monetarist school of economics?
Milton Friedman
What assumptions does monetarism make about the equation of exchange?
Velocity is a stable function of a few variables. Output may change in the short run, but in the long run, output is at the economy’s potential, with labor markets at equilibrium
What happens in the short run and in the long run in Friedman’s “helicopter drop” story?
In the short run, prices and output increase. In the long run, wages increase, causing output to be restored to potential, but with higher prices.
Under what conditions would inflation have zero effect on the economy?
If it is wholly anticipated and evenly spread throughout the economy
If all prices in the economy double, how does the amount of goods and services produced change?
The amount of goods and services produced do not change. The reward to production, in terms of goods and services, is the same as before the price change
What is a way to avoid being made worse off by anticipated inflation?
Buy goods whose prices inflate before the inflation starts
True, false, explain: With unanticipated inflation, borrowers gain and lenders lose
True. The borrower pays off the loan with inflated dollars, which are worthless.
What is the real interest rate?
Real rate = nominal rate = expected inflation rate
What is a secured loan?
A loan in which the lender can seize the borrower’s property if the loan is not repaid
What are the two problems with uneven inflation?
Prices no longer reflect value, so mistakes are made. Bubbles expand as systematic mistakes are made due to the inflation
Which economic “school” emphasized inflationary bubbles?
The Austrian school–Hayes, Mises, etc.
When someone pays an interest rate to someone, what are they paying that person to do?
To delay consumption
What is the difference between dollars saved and dollars created by the Fed?
Dollars saved have the potential to fuel later consumption, since they represent delayed consumption. Dollars made by the Fed do not have this potential.
What happens when a Fed-created inflationary bubble bursts?
Unwanted capital goods and constructions are abandoned and the workers that produced them must all find new jobs.
Why do the Austrians say that government and the central bank create bubbles, though private markets do not?
Because there must be coordinated failures by many individuals and firms. Government, especially through a government money supplier is the best coordinator.
What is “monetizing the debt?”
The central bank attempts to assist the state in its borrowing by purchasing debt in return for dollars
