Econ 12

If an economy always has inflation of 10 percent per year, which of the following costs of inflation will it NOT suffer? Shoe leather costs from reduced holdings of money. Menu costs from more frequent price adjustment. Distortions from the taxation of nominal capital gains. Arbitrary redistributions between debtors and creditors.

Arbitrary redistributions between debtors and creditors. Many of the costs of inflation, such as shoe leather costs, menu costs, and distortions from the taxation of nominal capital gains, occur even if inflation is steady and predictable. Expected inflation differs from unexpected inflation, however, in that expected inflation does not cause arbitrary distributions between debtors and creditors. That is, expected inflation can be built into loan and wage contracts, and therefore does not arbitrarily benefit or harm one party when inflation increases or decreases the value of the loan or wages

If nominal GDP is $400, real GDP is $200, and the money supply is $100, then the price level is ½, and velocity is 2. the price level is ½ , and velocity is 4. the price level is 2, and velocity is 2. the price level is 2, and velocity is 4.

The price level is 2, and the velocity is 4 Real GDP is equal to nominal GDP divided by the price level. Therefore, you can compute the price level in the following way: Real GDP = Nominal GDP / Price lvl 200 = 400 / Price lvl Price lvl = 2 The quantity equation states that the quantity of money ( M ) times the velocity of money ( V ) equals the price of output ( P ) times the amount of output ( Y ). Substituting the values from the problem yields the following: M x V = P x Y 100 x V = 2 x 200 V = 400 / 100 V = 4

Hyperinflations occur when the government runs a large budget ________, which the central bank finances with a substantial monetary ________. deficit, contraction deficit, expansion surplus, contraction surplus, expansion

deficit, expansion When the government runs a large budget deficit, tax revenue is insufficient to cover government spending. One way that the government can finance its spending is by printing money. Putting more money into the economy is known as monetary expansion; rapid monetary expansion in turn causes hyperinflation.

According to the quantity theory of money and the Fisher effect, if the central bank increases the rate of money growth, inflation and the nominal interest rate both increase. inflation and the real interest rate both increase. the nominal interest rate and the real interest rate both increase. inflation, the real interest rate, and the nominal interest rate all increase.

inflation and the nominal interest rate both increase. According to the principle of monetary neutrality, an increase in the rate of money growth does not affect any real variable. That is, the long-term effect of an increase of the rate of money growth is both a higher inflation rate and a higher nominal interest rate, but no change in the real interest rate. The real interest rate is equal to the nominal interest rate, corrected for inflation ( Real IR = Nominal IR + IR ). If inflation rises, the nominal interest will rise by the same amount in the long run, and the two effects will cancel themselves out in the calculation of the real interest rate.

The classical principle of monetary neutrality states that changes in the money supply do not influence ________ variables and is thought most applicable in the ________ run. nominal, short nominal, long real, short real, long

real, long Nominal variables are those measured in monetary units, while real variables are those measured in physical units. Changes in the money supply affect nominal variables, but not real ones. The classical principle of monetary neutrality may not be applicable in the short run (when real variables may be temporarily affected), but it is more applicable in the long run

According to the quantity theory of money, which variable in the quantity equation is most stable over long periods of time? money velocity price level output

velocity Of the variables in the quantity equation, the velocity of money is most stable over long periods. Between 1960 and the present, the money supply and nominal GDP both increased more than twentyfold. By contrast, the velocity of money, although not exactly constant, has not changed dramatically