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12 Money Growth and Inflation

12 Money Growth and Inflation - Money Growth and Inflation...

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Money Growth and Inflation The Meaning of Money Money is the set of assets in an economy that people regularly use to buy goods and services from other people. THE CLASSICAL THEORY OF INFLATION Inflation is an increase in the overall level of prices. Hyperinflation is an extraordinarily high rate of inflation. Inflation: Historical Aspects Over the past 60 years, prices in the U.S. have risen on average about 5 percent per year. Deflation, meaning decreasing average prices, occurred in the U.S. in the nineteenth century. Hyperinflation refers to high rates of inflation such as Germany experienced in the 1920s. The Level of Prices and the Value of Money The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate. Inflation is an economy-wide phenomenon that concerns the value of the economy’s medium of exchange. When the overall price level rises, the value of money falls. The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate. Inflation is an economy-wide phenomenon that concerns the value of the economy’s medium of exchange. When the overall price level rises, the value of money falls. Money Supply, Money Demand, and Monetary Equilibrium The money supply is a policy variable that is controlled by the Fed. Through instruments such as open-market operations, the Fed directly controls the quantity of money supplied. Money demand has several determinants, including interest rates and the average level of prices in the economy. People hold money because it is the medium of exchange. The amount of money people choose to hold depends on the prices of goods and services. In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply. 1 Quantity of Money Value of Money, 1/ P Price Level, P Quantity fixed by the Fed Money supply 0 1 (Low) (High) (High) (Low) 1 / 2 1 / 4 3 / 4 1 1.33 2 4 Equilibrium value of money Equilibrium price level Money demand A
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The Effects of a Monetary Injection The Quantity Theory of Money How the price level is determined and why it might change over time is called the quantity theory of money. The quantity of money available in the economy determines the value of money. The primary cause of inflation is the growth in the quantity of money.
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