MACROECO - Chapter 17 - Final Exam
During low rates of inflation what happens to debtors and creditors?
Creditors win and debtors lose
Relative-Price variability
Firms don't all raise prices at the same time, so relative prices can vary which distorts the allocation of resources
Arbitrary redistributions of wealth
Higher-than-expected inflation transfers purchasing power from creditors to debtors
How do people avoid inflation tax?
Hold less money and go to the bank more often
Inflation
Increase in the overall level of prices
What does an increase in the money supply do to demand?
Increased demand for goods and services
What does increasing P do to the money supply?
Increases (Excess money supply)
What does inflation do to prices?
Increases them
Inflation-induced tax distortions
Inflation makes nominal income grow faster than real income.
What does a rise in the price level mean for the value of money?
Lower value of money
Quantity equation
M x V = P x Y
Nominal variables
Nominal GDP, nominal interest rate, nominal wage
Monetary developments affect what variables?
Nominal variables
What happens to the nominal variables if the central bank doubles the money supply?
Nominal variables including prices will double, real variables are unaffected
What does a rise in the price level mean for goods and services?
People have to pay more for the goods and services they buy
Value of money
Quantity of goods and services that can be bought with $1
Real variables
Real GDP, real interest rate, real wage
What does deflation cause?
Redistribution of wealth away from debtors who are often poorer
What are the costs associated with inflation?
Shoe leather costs, menu costs, relative-price variability, inflation-induced tax distortions, confusion and inconvenience, and arbitrary redistributions of wealth
Monetary changes have what kind of effects on real variables?
Short-run
What determines the money supply?
The Fed, banking system, and consumers
Most economists believe that classical dichotomy and neutrality of money describe the economy in what?
The long run
Velocity of money formula
V = (P x Y) (price level x real GDP) / M (money supply)
Example of hyperinflation
Venezuela
What does money demand reflect?
how much wealth people want to hold in liquid form
Confusion and Inconvenience
inflation makes it difficult to compare dollar amounts over time so long-term planning is difficult
Real interest rate
nominal interest rate - inflation rate
What is the real interest rate?
nominal interest rate - inflation rate
Price level (P)
number of dollars needed to buy a basket of goods and services
Nominal interest rate
real interest rate + inflation rate
Nominal interest rate formula
real interest rate + inflation rate
Menu costs
the costs of changing prices
Fisher effect
the one-for-one adjustment of the nominal interest rate to the inflation rate
What does money demand depend on?
the price level and the interest rate
Monetary neutrality
the proposition that changes in the money supply do not affect real variables
Velocity of money
the rate at which money changes hands
Shoe leather costs
the resources wasted when inflation encourages people to reduce their money holdings
Inflation tax
the revenue the government raises by creating (printing) money
Classical Dichotomy
the theoretical separation of nominal and real variables
Friedman Rule
the theory that small and predictable amounts of deflation would be good
Inflation fallacy
"Inflation robs people of the purchasing power of his hard-earned dollars"
When the Fed increases the rate of money growth, the LONG-RUN result is...
- Higher inflation rate - Higher nominal interest rate
The quantity equation shows that an increase in the quantity of money in an economy must be reflected in any of these variables
- Price level must rise - The quantity of output must rise - Velocity of money must fall
How does deflation arise?
Broader macroeconomic difficulties
What does inflation do?
Changes the yardstick we use to measure transactions
Who came up with the Classical Dichotomy?
David Hume
During high rates of inflation what happens to debtors and creditors?
Debtors gain and creditors lose
An increase in price level (P) will do what to the value of money?
Decrease it
What does inflation do to the value of money?
Decreases it
What does inflation NOT do to people's real purchasing power
Does not in itself reduce people's real purchasing power
What does classical dichotomy suggest?
Economic variables should be divided into two groups: nominal variables and real variables
When prices rise what happens to sellers?
They get more
When prices rise what happens to buyers?
They pay more
Deflation
a decrease in the overall level of prices
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
Hyperinflation
an extraordinarily high rate of inflation
Principle of monetary neutrality
an increase in the rate of money growth raises the rate of inflation but does not affect any real variable
What does inflation do to the CPI?
causes the CPI and nominal wages to rise together over the long run
When do prices rise?
when the government prints too much money