Lecture 3 - 10/6/2009 MONEY&INFLATION PARTI EC205.01...

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10/6/2009 1 MONEY & INFLATION PART MONEY & INFLATION – PART I EC205.01 ALPER FALL 2009 1 ASSUMPTIONS UNTIL NOW 1. No money 2. No foreign economy 3. Full employment 4. Fixed stock of factors & level of technology 5. Fullyflexible prices EC205.01 ALPER FALL 2009 2 OUTLINE y The basics y What is money? y Types of money y Functions of money y The evolution of fiat money y The measures of money y Open market operations y The quantity theory of money (QTM)/Equation of exchange y Money Demand y Real vs. Nominal Interest Rates y The cost of holding money y The social costs of inflation y Hyperinflation y The Classical Dichotomy EC205.01 ALPER FALL 2009 3
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10/6/2009 2 What is money? y Stock of assets that can readily be used to make transactions y Currency in the hands of the public y Nation’s money stock EC205.01 ALPER FALL 2009 4 Types of money y Fiat money y No intrinsic value y Commodity money y Intrinsic value y e.g. Gold or money redeemable for gold (gold standard) y Common during the late 19 th century y e.g. Cigarettes in POW camps y Problems with barter: double coincidence of wants EC205.01 ALPER FALL 2009 5 Functions of money y Store of value y Transfer purchasing power from the present to the future y Unit of account y Terms in which prices are quoted y Medium of exchange y Liquidity y What we use to make transactions y Money–stock Income–flow EC205.01 ALPER FALL 2009 6
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10/6/2009 3 The evolution of fiat money y Commodity money can facilitate exchange–no surprise y People are willing to accept commodity money because it has intrinsic value y What would make people begin to value something intrinsically useless? EC205.01 ALPER FALL 2009 7 Transaction costs with commodity money y Consider an economy where buyers & sellers carry bags of gold! y For each transaction, measure the appropriate amount of gold for payment y If the seller thinks that the weight and the purity of the gold is right, then exchange occurs. y Governments can intervene and mint coins of gold with known purity & weight ‐‐‐ standardization y Easier to use: values are widely recognized EC205.01 ALPER FALL 2009 8 … gold certificates y Governments can accept gold from the public in exchange for gold certificates (pieces of paper redeemable for a certain amount of gold) y If people believe then the piece of paper is as good as If people believe ‐‐‐ gold y Bills are lighter y Eventually no one carries bags of gold, everyone uses bills for transactions EC205.01 ALPER FALL 2009 9
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10/6/2009 4 … and gold backing becomes irrelevant y Final stage–gold backing is no longer necessary y Nobody bothers to redeem the bills for gold anyway y No one cares if it is abandoned y As long as everyone continues to value the paper bills in exchange ‐‐‐ no problem EC205.01 ALPER FALL 2009 10 Measures of money y
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Lecture 3 - 10/6/2009 MONEY&INFLATION PARTI EC205.01...

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