Chapter 17 Money Growth and Inflation

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Chapter 17Money Growth and Inflation
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Contents of the Chapter

• Theoretical framework of inflation
• Money market Money in long-run
• Velocity quantity equation
• Why is inflation a problem?

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The Classical Theory of Inflation

• Increase of nominal price level (price tags) is
  not caused by increase in demand but simply
  caused by decease in the value of money.

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What determines the value of money?

• Supply and demand
• Money Supply
• Money Demand
• How much cash people want to hold

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Application

• An expansionary monetary policy (MS increases)
• Decrease of the value of money
• Increase of price level (inflation)

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The Classical Dichotomy and Monetary Neutrality

• The classical dichotomy
• Division of real and nominal variables in the
  economy
• i.e. measured by money --- nominal
• measured by unit --- real (relative
  prices)

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The classical (contd)

• Nominal variables influenced by monetary system
• Real variables influenced by supply and demand

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• Thus, changes of money supply will only affect
  nominal variables but not real variables
  Monetary Neutrality.
• Monetary Neutrality only exists in long-run not
  short-run.

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Velocity and Quantity Equation

• Another perspective to look at money neutrality
• Money supply is not only determined by physical
  amount of money but also velocity
• V (PY)/M

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• Quantity equation
• M V P Y
• When you increase money supply
• Velocity the same -gt increase price
• Velocity the same -gt quantity of output increases

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• In practice, we find that money velocity is
  stable. Thus, if Fed increases money supply (in
  the long-run)
• Quantity of output is the same ( sine it is only
  determined by real factors (not nominal factors,
  like money).
• Only price will rise.
• Faster money supply growth is, higher inflation
  we have

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Case study What is the real cause of
Hyperinflation

• Government print too much money
• Inflation tax

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Case study Fisher Effect

• Nominal and real interest rates in long-run
• MS increases
• Real interest rate stay put
• Increases of MS are transferred to increases of
  nominal interest rate.
• Why is it important?
• Business contract. (inflation)

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Cost of Inflation

• Inflation does not reduce peoples real
  purchasing power.

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• Then, why inflation is bad for us?
• Shoeleather costs
• Menu costs
• Relative Price Variability and the Misallocation
  of Resources
• Tax
• Unexpected Inflation Arbitrary Redistributions
  of Wealth
• Inconvenience