Money Growth + Inflation

Question 1

Define Inflation

Answer 1

Increase in Overall Level of Prices

- General Price Level

Question 2

Define Deflation

Answer 2

Decrease in Overall Level of Prices

Question 3

Define Hyperinflation

Answer 3

Extremely high rates of Inflation

Question 4

What does Inflation/Rise in P.L imply?

Answer 4

1. People have to pay More for G+S
2. Value of Money falls- 1/P
   - -> Decreased Q. of G+S that can be bought with £1

Question 5

What determines the Value of Money?

Answer 5

D + S of Money

Question 6

In SR- what equilibrates D+S?

Answer 6

Interest Rates

Question 7

In LR- what equilibrates D+S?

Answer 7

Price Level

Question 8

What is Classical Theory of Money?

Answer 8

M.S determined by C.B- via OMOs + Banking System (m)
- Treat M.S as Fixed- Vertical Supply curve
M.D depends on Average Price Level, P, in the Economy
- Determined by amount of wealth people want in Liquid form
As Value of Money Increases–> M.D Decreases
In LR- Price Level, P, adjusts to where M.D = M.S

Question 9

What is Quantity Theory of Money?

Answer 9

Growth Rate in Q. of Money
- Determines Inflation Rate
Increased Q. of Money–> Decreased Value of Money–> Increased Price Level

Question 10

What is the adjustment Process for Quantity Theory of Money?

Answer 10

Excess M.S –> Increased D for G+S –>Increased Price of G+S –> Increased M.D –> Decreased Value of Money (1/P)

Question 11

What 3 things do Monetary Injections NOT affect in LR?

Answer 11

• Real GDP
• Employment
• Real I.R etc.

Question 12

What is Classical Dichotomy?

Answer 12

Theoretical separation of Nominal + Real variables

Question 13

Define Nominal Variables

Answer 13

Variables Measured in Monetary Units

- e.g. £, $, €

Question 14

Define Real Variables

Answer 14

Variables Measured in Physical Units

- e.g. Relative Prices, Real Wages, Real I.R

Question 15

What do Developments in Monetary System influence?

Answer 15

Nominal Variables

- Irrelevant for explaining Real variables

Question 16

What is Monetary Neutrality?

Answer 16

Changes in M.S do NOT affect Real Variables

- Mostly correct in LR

Question 17

What is the Fisher / Velocity + Quantity equation?

Answer 17

MV = PY

• M = Q. of Money
• V = rate at which money changes hands in economy (velocity)
• P = Price Level
• Y = Output

Question 18

What does PY show?

Answer 18

£ Value of Economy’s Output of G+S

Question 19

What is the common notation of the Fisher Equation?

Answer 19

V = PY / M

Question 20

What is the conclusion of the Fisher Equation?

Answer 20

Over LR- V is relatively Stable over time
– Y is NOT affected by Money- determined by Factor supplies
THEREFORE- only Increased M –> Increased P
- In LR- Q. of Money affects Inflation

Question 21

What is the Principle of Monetary Neutrality?

Answer 21

Increased Rate of Money Growth–> Higher Inflation Rate

- BUT does NOT affect any Real variables

Question 22

How is Real I.R calculated?

Answer 22

Real I.R = Nominal I.R - Inflation

=> Nominal I.R = Real I.R + Inflation Rate

Question 23

What determines the Real I.R?

Answer 23

D + S for Loanable Funds

Question 24

What determines Inflation?

Answer 24

Money Growth

Question 25

What is the Fisher Effect?

Answer 25

One-for-One adjustment of Nominal I.R to Inflation when C.B Increases Money Growth

Question 26

When in SR does Fisher Effect NOT hold?

Answer 26

If Inflation is Unexpected

Question 27

What is the Inflation Tax?

Answer 27

Revenue Gov. raises by creating (issuing) Money - Rather than Raise Taxes or Selling Bonds - TAX on Everyone who Holds Money

Question 28

What is the process of Inflation Tax?

Answer 28

Gov. Prints Money --> Increases Q. of Money --> Reduces Value of Money --> Increased Price Level

Question 29

Why is the Inflation Tax roughly proportional?

Answer 29

Rich pay Proportionately More- hold more money

Question 30

what are the 3 main costs of Inflation?

Answer 30

- Inflation Fallacy - Shoe-leather Costs - Menu Costs

Question 31

What is Inflation Fallacy?

Answer 31

Inflation robs people of Purchasing Power of their money - Prices Rise --> Buyers pay more - - BUT Wage earners get paid more as well - Therefore- Relative Prices remain the Same

Question 32

What are Shoe-leather costs?

Answer 32

Resources wasted when there is Inflation - Encourages people to hold money in bank to Minimise Cost of Inflation Tax --> Go to Bank more often- Reduced Productivity

Question 33

What are Menu Costs?

Answer 33

Costs of Changing Prices | - Reprinting Menus etc.

Question 34

What do Market Economics + Misallocation say?

Answer 34

Relative Prices Allocate Scarce resources - Inflation distorts Relative Prices --> Consumer Decisions distorted - Markets- Less able to allocate resources to best use

Question 35

What causes Arbitrary Redistribution of Wealth?

Answer 35

Unexpected Inflation

Question 36

How does Unexpected Inflation Redistribute Wealth among Population?

Answer 36

Redistributes among Debtors + Creditors | - Since loans are Specified in £s

Question 37

Why might Deflation be worse than Inflation?

Answer 37

Downward Cycle- Debt Deflation - Cheaper to Spend later than Today --> Spending + Investment Deferred --> Decreases Output --> Decreased Real GDP --> Higher Unemployment + More Deflation