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1、MACROECONOMICS 2010 Worth Publishers, all rights reserved 2010 Worth Publishers, all rights reservedS E V E N T H E D I T I O NPowerPoint Slides by Ron CronovichN. Gregory MankiwC H A P T E RMoney and Inflation4Modified for EC 204 by Bob MurphyIn this chapter, you will learn:The classical theory of
2、inflationcauseseffectssocial costs“Classical” assumes prices are flexible & markets clear Applies to the long run Inflation and its trend, 1960-2009-3%0%3%6%9%12%15%19601965197019751980198519901995200020052010long-run trend% change in CPI from 12 months earlierCHAPTER 4 Money and InflationThe connec
3、tion between money and pricesInflation rate = the percentage increase in the average level of prices. Price = amount of money required to buy a good. Because prices are defined in terms of money, we need to consider the nature of money, the supply of money, and how it is controlled.4CHAPTER 4 Money
4、and InflationMoney: DefinitionMoney is the stock of assets that can be readily used to make transactions.5CHAPTER 4 Money and InflationMoney: Functionsmedium of exchangewe use it to buy stuffstore of valuetransfers purchasing power from the present to the futureunit of accountthe common unit by whic
5、h everyone measures prices and values6CHAPTER 4 Money and InflationMoney: Types1.Fiat moneyhas no intrinsic valueexample: the paper currency we use2.Commodity moneyhas intrinsic valueexamples: gold coins, cigarettes in P.O.W. camps7CHAPTER 4 Money and InflationThe money supply and monetary policy de
6、finitionsThe money supply is the quantity of money available in the economy. Monetary policy is the control over the money supply. 9CHAPTER 4 Money and InflationThe central bankMonetary policy is conducted by a countrys central bank. In the U.S., the central bank is called the Federal Reserve (“the
7、Fed”).The Federal Reserve Building Washington, DC10CHAPTER 4 Money and InflationMoney supply measures, May 2009$8328M1 + small time deposits, savings deposits, money market mutual funds, money market deposit accountsM2$1596C + demand deposits, travelers checks, other checkable depositsM1$850Currency
8、Camount ($ billions)assets includedsymbol11CHAPTER 4 Money and InflationThe Quantity Theory of MoneyA simple theory linking the inflation rate to the growth rate of the money supply.Begins with the concept of velocity12CHAPTER 4 Money and InflationVelocitybasic concept: the rate at which money circu
9、latesdefinition: the number of times the average dollar bill changes hands in a given time periodexample: In 2009, $500 billion in transactionsmoney supply = $100 billionThe average dollar is used in five transactions in 2009So, velocity = 513CHAPTER 4 Money and InflationVelocity, cont.This suggests
10、 the following definition:where V = velocityT = value of all transactionsM = money supply14CHAPTER 4 Money and InflationVelocity, cont.Use nominal GDP as a proxy for total transactions. Then, where P = price of output (GDP deflator) Y = quantity of output (real GDP)P Y = value of output (nominal GDP
11、)15CHAPTER 4 Money and InflationThe quantity equationThe quantity equationM V = P Yfollows from the preceding definition of velocity.It is an identity: it holds by definition of the variables.16CHAPTER 4 Money and InflationMoney demand and the quantity equationM/P = real money balances, the purchasi
12、ng power of the money supply.A simple money demand function: (M/P )d = k Ywherek = how much money people wish to hold for each dollar of income. (k is exogenous)17CHAPTER 4 Money and InflationMoney demand and the quantity equationmoney demand: (M/P )d = k Y quantity equation: M V = P YThe connection
13、 between them: k = 1/VWhen people hold lots of money relative to their incomes (k is large), money changes hands infrequently (V is small).18CHAPTER 4 Money and InflationBack to the quantity theory of moneystarts with quantity equationassumes V is constant & exogenous:Then, quantity equation becomes
14、:19CHAPTER 4 Money and InflationThe quantity theory of money, cont.How the price level is determined:With V constant, the money supply determines nominal GDP (P Y ).Real GDP is determined by the economys supplies of K and L and the production function (Chap 3).The price level is P = (nominal GDP)/(r
15、eal GDP).20CHAPTER 4 Money and InflationThe quantity theory of money, cont.Recall from Chapter 2: The growth rate of a product equals the sum of the growth rates. The quantity equation in growth rates:21CHAPTER 4 Money and InflationThe quantity theory of money, cont. (Greek letter “pi”) denotes the
16、inflation rate:The result from the preceding slide:Solve this result for :22CHAPTER 4 Money and InflationThe quantity theory of money, cont.Normal economic growth requires a certain amount of money supply growth to facilitate the growth in transactions. Money growth in excess of this amount leads to
17、 inflation. 23CHAPTER 4 Money and InflationThe quantity theory of money, cont.Y/Y depends on growth in the factors of production and on technological progress (all of which we take as given, for now).Hence, the Quantity Theory predicts a one-for-one relation between changes in the money growth rate
18、and changes in the inflation rate. 24CHAPTER 4 Money and InflationConfronting the quantity theory with dataThe quantity theory of money implies:1.Countries with higher money growth rates should have higher inflation rates.2.The long-run trend behavior of a countrys inflation should be similar to the
19、 long-run trend in the countrys money growth rate.Are the data consistent with these implications?25International data on inflation and money growthMoney supply growth(percent, logarithmic scale)SingaporeEcuadorTurkeyBelarusArgentinaIndonesiaU.S. inflation and money growth, 1960-2009-3%0%3%6%9%12%15
20、%19601965197019751980198519901995200020052010inflation rateM2 growth rateOver the long run, the rates of inflation and money growth move together, as the Quantity Theory predicts.CHAPTER 4 Money and InflationSeigniorageTo spend more without raising taxes or selling bonds, the govt can print money.Th
21、e “revenue” raised from printing money is called seigniorage (pronounced SEEN-your-idge).The inflation tax:Printing money to raise revenue causes inflation. Inflation is like a tax on people who hold money.28CHAPTER 4 Money and InflationInflation and interest ratesNominal interest rate, inot adjuste
22、d for inflationReal interest rate, radjusted for inflation:r = i 29CHAPTER 4 Money and InflationThe Fisher effectThe Fisher equation: i = r + Chap 3: S = I determines r . Hence, an increase in causes an equal increase in i.This one-for-one relationship is called the Fisher effect. 30U.S. inflation a
23、nd nominal interest rates, 1960-2009inflation ratenominal interest rateInflation and nominal interest rates across countriesNominal interest rate(percent, logarithmic scale)Inflation rate(percent, logarithmic scale)ZimbabweRomaniaTurkeyBrazilIsraelU.S.GermanyEthiopiaKenyaGeorgiaCHAPTER 4 Money and I
24、nflationTwo real interest ratesNotation: = actual inflation rate (not known until after it has occurred)E = expected inflation rateTwo real interest rates:i E = ex ante real interest rate: the real interest rate people expect at the time they buy a bond or take out a loani = ex post real interest ra
25、te:the real interest rate actually realized35CHAPTER 4 Money and InflationMoney demand and the nominal interest rateIn the quantity theory of money, the demand for real money balances depends only on real income Y. Another determinant of money demand: the nominal interest rate, i. the opportunity co
26、st of holding money (instead of bonds or other interest-earning assets). Hence, i in money demand. 36CHAPTER 4 Money and InflationThe money demand function(M/P )d = real money demand, dependsnegatively on i i is the opp. cost of holding moneypositively on Y higher Y more spending so, need more money
27、(“L” is used for the money demand function because money is the most liquid asset.)37CHAPTER 4 Money and InflationThe money demand functionWhen people are deciding whether to hold money or bonds, they dont know what inflation will turn out to be. Hence, the nominal interest rate relevant for money d
28、emand is r + E.38CHAPTER 4 Money and InflationEquilibriumThe supply of real money balancesReal money demand39CHAPTER 4 Money and InflationWhat determines whatvariablehow determined (in the long run)Mexogenous (the Fed)radjusts to ensure S = IY P adjusts to ensure40CHAPTER 4 Money and InflationHow P
29、responds to MFor given values of r, Y, and E , a change in M causes P to change by the same percentage just like in the quantity theory of money. 41CHAPTER 4 Money and InflationWhat about expected inflation? Over the long run, people dont consistently over- or under-forecast inflation, so E = on ave
30、rage. In the short run, E may change when people get new information. EX: Fed announces it will increase M next year. People will expect next years P to be higher, so E rises. This affects P now, even though M hasnt changed yet. 42CHAPTER 4 Money and InflationHow P responds to EFor given values of r
31、, Y, and M ,43NOW YOU TRY: Discussion QuestionWhy is inflation bad? What costs does inflation impose on society? List all the ones you can think of.Focus on the long run.Think like an economist.CHAPTER 4 Money and InflationA common misperceptionCommon misperception: inflation reduces real wagesThis
32、is true only in the short run, when nominal wages are fixed by contracts.(Chap. 3) In the long run, the real wage is determined by labor supply and the marginal product of labor, not the price level or inflation rate. Consider the data45The CPI and Average Hourly Earnings, 1965-20091965 = 100Hourly
33、wage in May 2009 dollars$0$5$10$15$2001002003004005006007008009001965197019751980198519901995200020052010CPI (1965 = 100)Nominal average hourly earnings, (1965 = 100)Real average hourly earnings in 2009 dollars, right scaleCHAPTER 4 Money and InflationThe classical view of inflationThe classical vie
34、w: A change in the price level is merely a change in the units of measurement.Then, why is inflation a social problem?47CHAPTER 4 Money and InflationThe social costs of inflationfall into two categories:1. costs when inflation is expected2. costs when inflation is different than people had expected
35、48CHAPTER 4 Money and InflationThe costs of expected inflation: 1. Shoeleather costdef: the costs and inconveniences of reducing money balances to avoid the inflation tax. i real money balancesRemember: In long run, inflation does not affect real income or real spending.So, same monthly spending but
36、 lower average money holdings means more frequent trips to the bank to withdraw smaller amounts of cash. 49CHAPTER 4 Money and InflationThe costs of expected inflation: 2. Menu costsdef: The costs of changing prices.Examples:cost of printing new menuscost of printing & mailing new catalogsThe higher
37、 is inflation, the more frequently firms must change their prices and incur these costs. 50CHAPTER 4 Money and InflationThe costs of expected inflation: 3. Relative price distortionsFirms facing menu costs change prices infrequently.Example: A firm issues new catalog each January. As the general pri
38、ce level rises throughout the year, the firms relative price will fall. Different firms change their prices at different times, leading to relative price distortionscausing microeconomic inefficiencies in the allocation of resources. 51CHAPTER 4 Money and InflationThe costs of expected inflation: 4.
39、 Unfair tax treatmentSome taxes are not adjusted to account for inflation, such as the capital gains tax. Example:Jan 1: you buy $10,000 worth of IBM stockDec 31: you sell the stock for $11,000, so your nominal capital gain is $1000 (10%). Suppose = 10% during the year. Your real capital gain is $0.
40、 But the govt requires you to pay taxes on your $1000 nominal gain!52CHAPTER 4 Money and InflationThe costs of expected inflation: 5. General inconvenienceInflation makes it harder to compare nominal values from different time periods.This complicates long-range financial planning. 53CHAPTER 4 Money
41、 and InflationAdditional cost of unexpected inflation: Arbitrary redistribution of purchasing powerMany long-term contracts not indexed, but based on E .If turns out different from E , then some gain at others expense. Example: borrowers & lenders If E , then (i ) (i E ) and purchasing power is tran
42、sferred from lenders to borrowers.If E , then purchasing power is transferred from borrowers to lenders.54CHAPTER 4 Money and InflationAdditional cost of high inflation: Increased uncertaintyWhen inflation is high, its more variable and unpredictable: turns out different from E more often, and the d
43、ifferences tend to be larger (though not systematically positive or negative) Arbitrary redistributions of wealth become more likely. This creates higher uncertainty, making risk averse people worse off. 55CHAPTER 4 Money and InflationOne benefit of inflationNominal wages are rarely reduced, even wh
44、en the equilibrium real wage falls. This hinders labor market clearing. Inflation allows the real wages to reach equilibrium levels without nominal wage cuts.Therefore, moderate inflation improves the functioning of labor markets. 56CHAPTER 4 Money and InflationHyperinflationCommon definition: 50% p
45、er monthAll the costs of moderate inflation described above become HUGE under hyperinflation. Money ceases to function as a store of value, and may not serve its other functions (unit of account, medium of exchange). People may conduct transactions with barter or a stable foreign currency. 57CHAPTER
46、 4 Money and InflationWhat causes hyperinflation?Hyperinflation is caused by excessive money supply growth:When the central bank prints money, the price level rises.If it prints money rapidly enough, the result is hyperinflation. 58A few examples of hyperinflationcountryperiodCPI Inflation % per yea
47、rM2 Growth % per yearIsrael1983-85338%305%Brazil1987-941256%1451%Bolivia1983-861818%1727%Ukraine1992-942089%1029%Argentina1988-902671%1583%Dem. Republic of Congo / Zaire1990-963039%2373%Angola1995-964145%4106%Peru1988-905050%3517%Zimbabwe2005-075316%9914%CHAPTER 4 Money and InflationWhy governments
48、create hyperinflationWhen a government cannot raise taxes or sell bonds, it must finance spending increases by printing money.In theory, the solution to hyperinflation is simple: stop printing money.In the real world, this requires drastic and painful fiscal restraint. 60CHAPTER 4 Money and Inflatio
49、nThe Classical DichotomyReal variables: Measured in physical units quantities and relative prices, for example: quantity of output producedreal wage: output earned per hour of workreal interest rate: output earned in the future by lending one unit of output todayNominal variables: Measured in money
50、units, e.g.,nominal wage: Dollars per hour of work.nominal interest rate: Dollars earned in future by lending one dollar today.the price level: The amount of dollars needed to buy a representative basket of goods.61CHAPTER 4 Money and InflationThe Classical DichotomyNote: Real variables were explain
51、ed in Chap 3, nominal ones in Chapter 4. Classical dichotomy: the theoretical separation of real and nominal variables in the classical model, which implies nominal variables do not affect real variables. Neutrality of money: Changes in the money supply do not affect real variables. In the real worl
52、d, money is approximately neutral in the long run. 62Chapter SummaryMoneydef: the stock of assets used for transactions functions: medium of exchange, store of value, unit of account types: commodity money (has intrinsic value), fiat money (no intrinsic value)money supply controlled by central bankQ
53、uantity theory of money assumes velocity is stable, concludes that the money growth rate determines the inflation rate. Chapter SummaryNominal interest rateequals real interest rate + inflation ratethe opp. cost of holding moneyFisher effect: Nominal interest rate moves one-for-one w/ expected infla
54、tion. Money demanddepends only on income in the Quantity Theoryalso depends on the nominal interest rate if so, then changes in expected inflation affect the current price level. Chapter SummaryCosts of inflationExpected inflationshoeleather costs, menu costs, tax & relative price distortions, incon
55、venience of correcting figures for inflationUnexpected inflationall of the above plus arbitrary redistributions of wealth between debtors and creditorsChapter SummaryHyperinflationcaused by rapid money supply growth when money printed to finance govt budget deficitsstopping it requires fiscal reform
56、s to eliminate govts need for printing moneyChapter SummaryClassical dichotomyIn classical theory, money is neutral-does not affect real variables. So, we can study how real variables are determined w/o reference to nominal ones.Then, money market eqm determines price level and all nominal variables. Most economists believe the economy works this way in the long run.
