Macro Chapter 5

Real money balances

Represents the purchasing power of a given stock of money

What does the parameter k mean?

hows how much money people want to hold for every dollar of income If people are holding fewer dollars, then each dollar must be used more times to purchase the same quantity of good and services, which means higher velocity of money

What is the opportunity cost of holding money? A the real rate of interest B the expected rate of inflation C the real rate of interest - the expected rate of inflation D the real rate of interest + the expected rate of inflation

real rate of interest

Menu costs

result of firms having to change their posted prices more often

Shoe leather costs

result of people having to convert bonds into money. As prices go up, you have to convert money more and more often The cost of inflation from reducing real money balances, such as the inconvenience of needing to make more frequent trips to the bank.

Inflation is measured as...

the percentage change in the price level

Because most loans are specified in nominal terms, high ??? inflation hurts ???. expected, debtors expected, creditors unexpected, debtors unexpected, creditors

unexpected, creditors

Nominal variables

variables measured in monetary units

Real variables

variables measured in physical units

Costs of unexpected inflation

-Arbitrary redistribution of purchasing power: real returns on loans decrease :( -Increased uncertainty

Money has a real return of...

-e(pi) (expected rate of inflation)

Fisher effect

1% increase in money supply= 1% increase in inflation and 1% increase in inflation= 1% increase in nominal interest rate

What was the peak of inflation in US in 1979/1980?

13%

Zimbawe inflation

18000% per month. Made US dollar the official currency to rectify

Suppose that expected inflation is 5 percent and the nominal interest rate is 8 percent. If actual inflation is 2 percent lower than expected, then the ex ante real interest rate is _____, the ex post real interest rate is 5 percent, and there is an unexpected transfer of wealth from _____.

3; borrowers to lenders

Suppose the demand for real money balances is equal to Y/5i. The velocity of money is ___. A 5i B 5 C 1/5i D 1/5

5i

Benefits of inflation

Allows the central bank to use negative real interest rates as a policy tool easier to reduce real wages by raising nominal wages by less than the rate of inflation

Joe buys a bond with a nominal interest rate of 6% that will mature in 2 years. In the next year, prices unexpectedly double in price. What is the cost of the inflation demonstrated by this example. A Businesses must post new prices more often. B There is an arbitrary redistribution of income from lenders to borrowers. C People will have to convert bonds to money more often. D The dollars usefulness as a measure of relative prices is undermined.

B

Why do people hold money? A Money pays a rate of return of r. B Money provides liquidity. C Money is both a liquid and interest bearing asset. D Money has a higher real rate of return than bonds.

B

When does hyperinflation begin/end?

Begins when central bank rapidly increases money supply Ends when central bank reduces rate of growth in money supply. Must reduce government spending and raise taxes

Hyperinflation is usually caused by ___. A large trade surplusses B too much saving C large government budget deficits D too much borrowing and investment

C

Which of the following represents the shoe leather cost of inflation? A Businesses must post new prices more often. B There is an arbitrary redistribution of income from lenders to borrowers. C People will have to convert bonds to money more often. D The dollars usefulness as a measure of relative prices is undermined.

C

If the expected inflation rate is 5 percent and the nominal interest rate is 8 percent, then the ex post real interest rate: is greater than 3 percent. cannot be determined. is less than 3 percent. is 3 percent.

Correct: cannot be determined

A potential benefit of inflation is ___. A the government earns more tax revenue B the nominal interest rate will always be above zero C borrowers learn to anticipate inflation D the labor market works more efficiently

D

Higher income ??? demand real money balances

Higher income= higher demand for real money balances

Higher nominal interest rate ??? demand for real money balances

Higher nominal interest= lower the demand for real money balances

Hyperinflation

Inflation that exceeds 50% per month

Real Money balances equation

M/P Quantity of money/price level

Inflation

Overall increase in prices

What does it mean for k to be big?

People want to hold a lot of their money inside. So, V is small (v=1/k)

Quantity theory of money says that

Quantity of money (M) determines the dollar value of the economy's output (P*Y) And because Y is fixed by production function, we can say that ... price level is proportional to the money supply So, money supply affects price level and therefore inflation level

Quantity theory of money

The doctrine emphasizing that changes in the quantity of money lead to changes in nominal GDP expenditure. Velocity of money is constant

Income velocity of money

The ratio of national income, as measured by GDP, to the money supply. The income velocity of money tells us the number of times a dollar bill enters someone's income in a given period of time. (V)

Ex post real interest rate

The real interest rate actually realized; the nominal interest rate minus actual inflation.

Ex ante real interest rate

The real interest rate anticipated when a loan is made; the nominal interest rate minus expected inflation

Real interest rate

The return to saving and the cost of borrowing after adjustment for inflation

Nominal interest rate

The return to saving and the cost of borrowing without adjustment for inflation

Seigniorage

The revenue raised by the government through the creation of money; also called the inflation tax.

Classical dichotomy

The theoretical separation of real and nominal variables in the classical model, which implies that nominal variables do not influence real variables.

If the demand for real money balances depends on the nominal interest rate, then higher inflation can increase the quantity of real money balances. reduce the nominal interest rate. be caused by an acceleration in the rate of real GDP growth. arise from the expectation of future money growth.

arise from the expectation of future money growth.

Hyperinflations tend to occur when monopoly firms raise prices above competitive levels. the menu costs of price changes become too small. central banks finance large government budget deficits. monetary policymakers act independently of fiscal policy.

central banks finance large government budget deficits.

A financial crisis that closes many bank branches and their respective automatic teller machines (ATMs) would _____ money velocity. increase and then decrease not affect decrease increase

decrease

The irrelevance of money in determining the values of real variable is known as ___.

monetary neutrality

Demand for liquidity is ??? related to nominal rate of interest

negative

Fisher equation

nominal interest rate = real interest rate + inflation Nominal interest rate changes because of real or because of inflation

Demand for real money balances depends on...

nominal interest rate and income

demand for liquidity is ??? related to income

positively

Bonds have a real return of...

r (real rate of interest)

Opportunity cost of holding money

r+e(pi)=i

Increase in the expected future money supply will do what to expected rate of inflation nominal rate of interest demand for real money balances price level

raise raise reduce increase