Macroeconomics 3

Quantity Theory of Money

-a theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate

Central bank

-an institution designed to oversee the banking system and regulate the quantity of money in the economy

Medium of exchange

-an item that buyers give to sellers when they want to purchase goods and services

Store of value

-an item that people can use to transfer purchasing power from the present to the future

Money refers to what?

-assets that people regularly use to buy goods and services from other people

The economies output of goods and services (Y) is determined by

-available resources and technology -money is neutral, changes in money supply do not affect output

Demand deposits

-balances in the bank accounts that depositors can access on demand by writing a check

If banks hold all deposits in reserve

-banks do not influence the supply of money

What are the ways that people try to get ride of excess supply?

-buy goods and services with the excess funds -make loans to others by buying bonds or depositing the money in a bank account (these loans are then used to buy goods and services)

Principle of monetary neutrality asserts?

-changes in the quantity of money influence nominal variables but not real variables

Persistent growth in the in the quantity of money supplied leads to?

-continuing inflation

Second job that the Fed performs is?

-control the quantity of money available in the economy

The immediate effect of an increase in money supply is to

-create an excess supply of money

Higher-than-expected inflation transfers purchasing power from

-creditors to debtors

Lower-than-expected inflation transfers purchasing power from

-debtors to creditors -deflation increases the real value of debt

The sale of government bonds

-decreases the money supply

Reserves

-deposits that banks have received but have not loaned out

Higher Discount Rate

-discourages banks from borrowing from the Fed and likely encourages banks to hold onto larger amounts of reserves -lowers the money supply

We use money to measure

-economic transactions

Lower Discount Rate

-encourages banks to lend their reserves (and borrow from the Fed) - increase the money supply

Hyperinflation ends when

-government cuts its spending and eliminates the need to create more money

The demand of money reflects

-how much wealth people want to hold in liquid form

If inflation is unexpected

-imposes risk on both creditors and debtors

The purchase of government bonds

-increases the money supply

When Fed increases the rate of growth of the money supply

-inflation rate increases, this will lead to increase in nominal interest rate

When central bank increases the supply of money then-

-it causes the price level to rise

If the Fed wants to increase money supply

-it creates dollars and uses them to purchase government bonds from the public through the nations bond market

If the Fed wants to decrease money supply

-it sells government bonds from its portfolio to the public -money is then taken out of the hands of the public and the supply of money falls

When central banks change the quantity of money (M)

-it will change the nominal value of output (P*Y)

Large increase in money supply leads to

-large amount in inflation

The amount of money created by banking systems depends on?

-loans made

A high value of money means

-low price level

To calculate velocity

-nominal GDP/money supply -velocity = P(price level, GDP deflator) * Y(real GDP) / M(quantity of money)

Tax laws do not deferentiate between

-nominal and real interest rate income and capital gains

What 2 groups should economic variables be divided into?

-nominal variables -real variables

Changes in money supply effect

-nominal variables but not real variables

Fisher Effect

-one application of the principle of monetary neutrality -when inflation rate rises the nominal interest rate rises at the same amount so that the real interest rate remains the same

Fiat Money

-paper dollars -money without intrinsic value, would be worthless if not used as money

If the price level is below equilibrium

-people will want to hold less money than than available and price will rise

If the price level is above equilibrium level

-people will want to hold more money that is available and prices will decline

What are important macroeconomic variables?

-production -employment -real wages -real interest rates

One of the jobs performed by the Fed is?

-regulation of banks to insure the health of the nation's banking system -monitors each banks financial condition and facilitates bank transaction by clearing checks -makes loans to banks they want or need to borrow

Reserve Requirements

-regulations of the minimum amount of reserves that banks must hold against deposits -this can affect the size of the money supply through changes in the money multiplier -the Fed rarely uses this because of the distribution in the banking industry that would be caused by frequent alterations of reserve requirements

Debtors

-repay their dept with dollars that aren't worth much -hyperinflation diminishes the real value of debt

Commodity Money

-such as gold -money that has intrinsic value, would be valued even if not used as money

Assume that the economy is currently in equilibrium and the Fed suddenly increases the supply of money

-supply of money shifts to the right -the equilibrium value of money falls and the price level rises

The supply of money is determined by

-the Fed -meaning that the quantity of money supplied is fixed until the Fed decides to change it -meaning that the supply of money will be vertical

Money Multiplier

-the amount of money the banking system generates with each dollar of reserves

Most economist believe that monetary neutrality describes

-the behavior of the economy in the long run

Federal Reserve (Fed)

-the central bank of the United States

Mean Costs

-the cost of changing prices -during period of inflation firms must change their prices often

The overall price level adjusts to the level at which

-the demand for money equals the supply of money

If the sale or purchase of government bonds affects the amount of deposits in the banking system

-the effect will be made larger by the money multiplier

Reserve Ratio

-the fraction of deposits that banks hold as reserves

What are the different patterns that most hyperinflation follows

-the government has a high level of spending and inadequate tax revenue to pay for its spending -the government's ability to borrow funds is limited as a result is turns to printing money for its spending

Growth in the money supply determines

-the inflation rate

Discount Rate

-the interest rate of the loans that the Fed makes to banks

The higher the price level

-the more money needed for transaction -a higher price level (and a lower value of money) leads to a higher quantity of money demand

The more money households deposit

-the more reserves the bank has and the more money the banks system can create

If inflation catches borrowers and lenders by surprise

-the nominal interest rate will fail to reflect the rise in prices

Currency

-the paper bills and coins in the hand of the public

One variable that is important in determining the demand for money is

-the price level

Open Market Opportunity

-the primary way in which the Fed increases or decreases the supply of money -which involves the purchase or sale of U.S. government bonds

Monetary Neutrality

-the proposition that changes in money supply do not affect real variables

Open Market Opportunity

-the purchases and sales of U.S. government bonds by Fed -are easy for the Fed to conduct and are therefore the tool of monetary policy

If P is price level then

-the quantity of goods and services that can be purchased with $1 is equal to 1/P

Money Supply

-the quantity of money available in the economy

Money stock

-the quantity of money circulating in the United States

Velocity of Money

-the rate at which money changes hands

The supply and demand for loanable funds determines

-the real interest rate

Shoeleather costs

-the resources wasted when inflation encourages people to reduce their money holding -this cost can be considerable in countries experiencing hyperinflation

When central banks increase money supply rapidly

-the result is a high level of inflation which in result leads to hyperinflation

Increase in the money supply makes dollars more plentiful

-the result is an increase in the price level that makes each dollar less valuable

Inflation Tax

-the revenue that the government raises by creating money

Monetary Policy

-the setting of the money supply by policymakers in the central bank

Federal Funds Rate

-the short term interest rate that banks charge one another for loans

The less money households deposit

-the small the amount the reserves banks have and the less money the bank system creates

The value of money is determined by

-the supply and demand for money

Classic Dichotomy

-the theoretical separation of nominal and real variables

Unit of account

-the yardstick people use to post prices and record debts

Relative prices are real

-they are not measured in money terms

Prices in economy are nominal

-they are quoted in units of money

Nominal Variables

-variables measured in monetary units

Real Variables

-variables measured in physical units

P increases

-when there is a change in M

Money Multiplier Equation

1/reserve ratio

Real Interest Rate Equation

nominal interest rate-inflation rate

Nominal Interest Rate Equation

real interest rate+inflation rate

Fisher effect

the one-for-one adjustment of the nominal interest rate to the inflation rate

Money serves 3 functions

-1st) it serves as a medium of exchange, provides item used to make transaction -2nd) it severs as a unit of account, provides the way in which prices and other economic values are record -3rd) it serves as a store of value,provides a way of transferring purchasing power from the present to the future

The Inflation Fallacy

-As price rises so does income which means that inflation does not reduce the purchasing power of incomes. This implies that the higher prices paid by the consumers are exactly offset by the higher incomes received b the seller. Individuals often get pay increases over time to compensate for increases in the cost of living.

Quantity Equation

-M*V=P*Y -which relates the quantity of money, the velocity of money, and the dollar value of the economy's output of goods and services -price level must rise, output must rise, or velocity must fall -explains how the increase in the quantity of money effects price level

M*V=P*Y

-M=quantity of money -V=velocity -P=price level, GDP deflator -Y=real GDP

Many people think that inflation what?

-Many people think that inflation makes them poorer because it raises the cost of what they buy, this view is false because inflation also raises nominal income

Fractional Reserve Banking

-a banking system in which banks hold only a fraction of deposits as reserves