Exam 2

Suppose the velocity of money in this economy was growing steadily because of financial innovation. What happens to inflation rate

If velocity growth is positive and increasing, all else equal, the inflation rate is higher. Inflation increases because the average dollar is being used more often to purchase items

Long run empirical regularities

In the long run, average inflation moves one for one with the average growth rate of the money supply In the long run, the average growth rate of output is unrelated to the average growth rate of the money supply

An economy with constant velocity has real GDP growth of 3 percent, money growth of 7 percent, and a real interest rate of 2 percent. What is nominal interest rate?

Inflation = money growth - real GDP growth 7-3 = 4 Nominal interest rate = real interest rate + inflation rate 2+4 = 6

Benefit of inflation

Inflation allows the real wages to reach equilibrium levels without nominal wage cuts. Wages hardly reduced

Stuff

Investment is same as savings Depreciation becomes same as new investment Higher savings rate will have higher saving curve Difference between investment and depreciation is growth of capital Poorer countries don't grow faster. Only if you compare them to similar countries

________ causes the capital stock to rise, while _________ causes the capital stock to fall

Investment; depreciation

National Banking Act of 1863

National banks could only issue bank notes backed by the US Treasury, it is a promise to pay a dollar

Are credit card transactions in the money supply?

No CC makes liabilities and therefore not in money supply

Two empirical regularities

countries with a high investment share tend to have higher income levels. Income convergence among rich countries: relatively low income countries tend to grow faster than relatively high income countries

What does parameter K mean

It defines how much money people want to hold for every dollar of income

Fisher Equation

real interest rate = nominal interest rate - inflation rate It = nominal interest rate in period t Rt = real interest rate in period t pie symbol t = inflation rate in period t

In the solow growth model, the economy ends up with a steady state level of capital,

regardless of the starting level of capital

3 building blocks of QTM

the demand for money equilibrium in the money market a dichotomy between prices and output

Real interest rate

the return of an asset measured in terms of goods

adaptive expectations

the theory that people look at past experience and gradually adapt their beliefs and behavior as circumstances change. Inflation

rational expectations

the view that individuals and firms make decisions optimally, using all available information

Why governments create hyperinflation

to spend more without raising taxes or selling bonds inflation is like a tax on people who hold money

Hyperinflation tends to occur when

central banks finance large government budget deficits

According to the Solow growth model, in the steady state the country with the higher savings rate will have ________ level of output per person and _________ rate of growth of output per worker compared to the country with the lower savings rate

higher; the same Level of output depends on savings rate but growth depends on productivity or efficiency of workers and it is assumed to be the same

Criticisms of QTM

monetary supernaturality is obtained by assumption expectations about future money growth play no role for prices QTM fails to capture the fact that money demand is interest elastic

QTM

price is proportional to money supply. If money in an economy doubles, so does price

Goals of Monetary Policy

1. price stability 2. high employment

Economy has 10 trillion January 1st and in 2018 there was an investment of 2 trillion and depreciation of 1 trillion. How much capital does it have

11 trillion

How would inflation be different if real income growth were higher

An increase in real income growth results in a lower average inflation rate

If the demand for real money balances depends on the nominal interest rate, then higher inflation can

Arise from the expectation of future money growth. When people expect a growth of money, it will lead to higher inflation as interest rate will fall when growth increases. Nominal interest rate is really opportunity cost of holding money and it is negatively related to demand for money

Issue with loans being in nominal terms

Since loans are specified in nominal terms, high unexpected inflation hurts the creditors

Cagan Model

an equation ensuring equilibrium in the money market

Fisher effect

an increase in expected inflation causes an equal increase in the nominal interest rate price level depends on both current and expected supply

QTM

asserts that a key determinant of the price level and inflation is the quantity of money issued by the central bank

QTM assumes

assumes that the demand for money is incentive to the nominal interest rate, where as in the cagan model the demand for money is decreasing in the nominal interest rate

19th Century America

banknotes circulated as money, bank IOUs, banknotes traded at a discount because of risk

If the demand for money depends on the nominal interest rate, then via the quantity theory and the fisher equation, the price level depends on

both the current and expected future money supply

If the Fed announces that it will raise the money supply in the future but does not change the money supply today,

both the nominal interest rate and the current price level will increase with announcement of increased money supply, people increase spending that will raise prices and rates

The U.S. Coinage Act of 1792

defined the dollar as legal tender and authorized free coinage of both silver and gold

Price level

depends on a weighted average of the current money supply and the money supply expected to prevail in the future. Inflation is driven by both current growth in the money supply and its expected future growth

Characteristics of money

durable, easily measured, easily transferable, easily divisible, and have stable value. Point of money is to lower transaction costs.

Most hyperinflations end with _____ reforms that eliminate the need for _____.

fiscal seigniorage (difference between value of money and cost to produce and distribute

Anticipated increase in money supply

general money demand equation implies that the price level depends not only on today's money supply but also the money supply expected in the future

US coinage act of 1834

gold-silver price ratio at US mint raised to 16 to 1. US switches to gold standard. Law passed because gold was found more

how to end hyperinflation

gradual reduction of the inflation or shock therapy. shock therapy rapidly changes peoples expectations. in theory the easy answer is stop printing money

When Roosevelt took office in 1933

he declared a bank holiday, takes the US off the gold standard and allows dollar to devalue substantially, expands government spending

According to the Solow model, if an economy increases its saving rate, then in the new steady state, compared with the old one, the marginal product of capital is _________ and the growth rate is ________

lower, the same When saving rate increases, steady state stock increases and causes output to increase. In the long run, movement from old to new state causes the marginal product of capital to lower and growth remains the same in new state. This is because capital is fixed in the long run and MPL lowers in a new state

Hyperinflation

money ceases to function as a store of value. people may conduct transactions with barter or foreign currency. It is caused by excessive money supply growth

which of the following would most likely be called a hyperinflation

price increases averaged 300 percent per year