inflation
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This document discusses money, inflation, and monetary policy. It defines money as assets used to purchase goods and services, and inflation as a general increase in prices. The quantity theory of money holds that inflation is primarily caused by increasing the money supply. When the money supply increases, the price level must also rise for monetary equilibrium to be maintained. Hyperinflation, with prices rising over 50% per month, can occur if a government prints too much money to fund spending. The costs of inflation include shoeleather costs, menu costs, and a redistribution of wealth through unexpected price changes.
inflation
- 1. Money Growth and Inflation Course: BBA-2 Subject: BE 2 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 • Macroeconomics: Theory and Policy-Vanita Agarwal, Pearson Publication • Macro Economics-D.M. Mithani, Himalaya Publishing House, Mumbai • Macro Economics-H.L.Ahuja, S. Chand and Company Ltd., Delhi • Macro Economic theory-M.C.Vaish, Vikas Publishing House, Delhi • Macro Economic Analysis-Edward Shapiro, Galyotia Publications (P) Ltd • Macro Economics-M.L. Seth, Lakshmi Narayan Agarwal Publishers