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