ECO 252 Chapter 17
Suppose the nominal interest rate is 7 percent while the money supply is growing at a rate of 5 percent per year. Assuming real output remains fixed, if the government increases the growth rate of the money supply from 5 percent to 9 percent, the Fisher effect suggests that, in the long run, the nominal interest rate should become
11 percent.
If the real interest rate is 4 percent, the inflation rate is 6 percent, and the tax rate is 20 percent, what is the after-tax real interest rate?
2 percent
If the nominal interest rate is 6 percent and the inflation rate is 3 percent, the real interest rate is
3 percent.
Countries that employ an inflation tax do so because
government expenditures are high and the government has inadequate tax collections and difficulty borrowing
In the long run, inflation is caused by
governments that print too much money
A government can pay for some of its spending by printing money; however, when the country relies heavily on this "inflation tax," the result is
hyperinflation
When prices rise at an extraordinarily high rate, it is called
hyperinflation.
If the money supply grows 5 percent, and real output grows 2 percent, prices should rise by
less than 5 percent
Suppose that, because of inflation, a business in Russia must calculate, print, and mail a new price list to its customers each month. This is an example of
menu costs
The quantity equation states that
money x velocity = price level x real output
Suppose that, because of inflation, people in Brazil economize on currency and go to the bank each day to withdraw their daily currency needs. This is an example of
shoeleather costs
The value of money and the price level adjust to bring
supply and demand back into balance
Velocity is
the annual rate of turnover of the money supply
Menu costs
the costs of changing prices
In the long run, the demand for money is most dependent upon
the level of prices
Fisher effect
the one-for-one adjustment of the nominal interest rate to the inflation rate
An increase in the money supply makes dollars more plentiful, _____________ increases, making each dollar _______ valuable
the price level, less
Monetary neutrality
the proposition that changes in the money supply do not effect real variables
Velocity of money
the rate which money changes hands
An example of a real variable is
the ratio of the value of wages to the price of soda.
Shoeleather cost
the resources wasted when inflation encourages people to reduce their money holdings
Classical dichotomy
the theoretical separation of nominal and real variables
If the price level doubles,
the value of money has been cut by half
When the Fed increases the supply of money, the money supply curve shifts
to the right
Nominal variables
variables measured in monetary units
Real variables
variables measured in physical units
If actual inflation turns out to be greater than people had expected, then
wealth was redistributed to borrowers from lenders
Velocity of money equation
(Price level x quantity of output) / Quantity of money
Quantity equation
(quantity of money x velocity of money) = (price of output x Amount of output), which relates the quantity of money, velocity of money, and the dollar value of the economy's output of goods and services
How the supply and demand for money determine the equilibrium for money determine the equilibrium price level:
- The horizontal axis shows the quantity of money - The left vertical axis shows the value of money - The right vertical axis shows the price level - The supply curve for money is vertical because the quantity of money supplied is fixed by the Fed. The demand curve for money is downward sloping because people want to hold a large quantity of money when each dollar buys less - At the equilibrium, the value of money and the price level have adjusted to bring quantity of money supplied and the quantity of money demanded into balance
Which of the following costs of inflation does not occur when inflation is constant and predictable?
Arbitrary redistributions of wealth.
Which of the following statements about inflation is not true?
Inflation reduces people's real purchasing power because it raises the cost of the things people buy.
Real interest rate
Nominal interest rate - inflation rate
An inflation tax is
a tax on people who hold money.
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
If money is neutral,
changes in the quantity of money do not affect real output.
