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1、Principles of Economics II: Macroeconomics Money Money Growth and InflationGrowth and Inflation The Economy in the Long Run E c o n o m i c G r o w t h H u m a n a n d P h y s i c a l , F i n a n c i a l C a p i t a l F o r m a t i o n M o n e y a n d P r i c e s Topics How does the money supply aff
2、ect inflation and nominal interest rates? Does the money supply affect real variables like real GDP or the real interest rate? How is inflation like a tax? What are the costs of inflation? How serious are they? Introduction This chapter introduces the quantity theory of money to explain one of the T
3、en Principles of Economics from Chapter 1: Prices rise when the govt prints too much money. Most economists believe the quantity theory is a good explanation of the long run behavior of inflation. The Value of Money P = the price level (e.g., the CPI or GDP deflator) P is the price of a basket of go
4、ods, measured in money. 1/P is the value of $1, measured in goods. Example: basket contains one candy bar. If P = $2, value of $1 is 1/2 candy bar If P = $3, value of $1 is 1/3 candy bar Inflation drives up prices and drives down the value of money. The Quantity Theory of Money Developed by 18th cen
5、tury philosopher David Hume and the classical economists Advocated more recently by Nobel Prize Laureate Milton Friedman Asserts that the quantity of money determines the value of money We study this theory using two approaches: 1.A supply-demand diagram 2.An equation Money Supply (MS) In real world
6、, determined by Federal Reserve, the banking system, consumers. In this model, we assume the Fed precisely controls MS and sets it at some fixed amount. Money Demand (MD) Refers to how much wealth people want to hold in liquid form. Depends on P: An increase in P reduces the value of money, so more
7、money is required to buy g what happens to relative prices? Initially, relative price of cd in terms of pizza is price of cd price of pizza = 1.5 pizzas per cd $15/cd $10/pizza = After nominal prices double, price of cd price of pizza = 1.5 pizzas per cd $30/cd $20/pizza = The relative price is unch
8、anged. The Neutrality of Money Similarly, the real wage W/P remains unchanged, so quantity of labor supplied does not change quantity of labor demanded does not change total employment of labor does not change The same applies to employment of capital and other resources. Since employment of all res
9、ources is unchanged, total output is also unchanged by the money supply. Monetary neutrality: the proposition that changes in the money supply do not affect real variables The Neutrality of Money Most economists believe the classical dichotomy and neutrality of money describe the economy in the long
10、 run. In later chapters, we will see that monetary changes can have important short-run effects on real variables. The Velocity of Money Velocity of money: the rate at which money changes hands Notation: P x Y = nominal GDP = (price level) x (real GDP) M = money supply V = velocity Velocity formula:
11、 V = P x Y M The Velocity of Money Example with one good: pizza. In 2008, Y = real GDP = 3000 pizzas P = price level = price of pizza = $10 P x Y = nominal GDP = value of pizzas = $30,000 M = money supply = $10,000 V = velocity = $30,000/$10,000 = 3 The average dollar was used in 3 transactions. Vel
12、ocity formula:V = P x Y M One good: corn. The economy has enough labor, capital, and land to produce Y = 800 bushels of corn. V is constant. In 2008, MS = $2000, P = $5/bushel. Compute nominal GDP and velocity in 2008. A C T I V E L E A R N I N G A C T I V E L E A R N I N G 1 1 ExerciseExercise U.S.
13、 Nominal GDP, M2, and Velocity (1960=100) 1960-2007 Nominal GDP M2 Velocity Velocity is fairly stable over time. The Quantity Equation Multiply both sides of formula by M: M x V = P x Y Called the quantity equation Velocity formula:V = P x Y M The Quantity Theory in 5 Steps 1.V is stable. 2.So, a ch
14、ange in M causes nominal GDP (P x Y) to change by the same percentage. 3.A change in M does not affect Y: money is neutral, Y is determined by technology & resources 4.So, P changes by same percentage as P x Y and M. 5.Rapid money supply growth causes rapid inflation. Start with quantity equation: M
15、 x V = P x Y A C T I V E L E A R N I N G A C T I V E L E A R N I N G 2 2 ExerciseExercise One good: corn. The economy has enough labor, capital, and land to produce Y = 800 bushels of corn. V is constant. In 2008, MS = $2000, P = $5/bushel. For 2009, the Fed increases MS by 5%, to $2100. a. Compute
16、the 2009 values of nominal GDP and P. Compute the inflation rate for 2008-2009. b. Suppose tech. progress causes Y to increase to 824 in 2009. Compute 2008-2009 inflation rate. If real GDP is constant, then inflation rate = money growth rate. If real GDP is growing, then inflation rate money growth rate. The bottom line: Economic growth increases # of transactions. Some money growth is needed
