Chapter 17 Money Growth and Inflation

Chapter 17 Money Growth and Inflation - Chapter 17 Money...

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Chapter 17 Money Growth and Inflation The Classical Theory of Inflation The Level of Prices and the Value of Money The first insight about inflation is that it is more about the value of the money than the value of goods. The economy’s overall price level can be viewed in two ways: 1. 2. The price level as a measure of the value of money. (price rise-->lower value of money) Money Supply, Money Demand, and Monetary Equilibrium Supply and demand determines the value of money. We must consider the determinants of money supply and demand to develop the quantity theory of money. Money supply: Policy variable that the Fed controls (ignore banking systems) Money demand: (reflects how much wealth people want to hold in liquid form.) Depends on how much people rely on credit cards, on whether an automatic teller machine is easy to find, and on the interest rate that a person could earn by using money to buy bonds rather than leave it in a wallet to a low interest checking account. A higher price level(or a lower value of money) increases the quantity of money deman- ded. In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply. (Look at figure 1 graph) The Effects of a Monetary injection When an increase in money supply makes dollars more plentiful, the result is an increase in the price level that makes each dollar less valuable. Quantity theory of Money-A theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate. A Brief Look at the Adjustment Process The injection of money increases the demand for goods and services. The economy’s output of goods and services is not altered by the injection of money, thus, the greater demand for goods and services causes the prices of goods and services to increase. The increase in price level, in turn, increases the quantity of money demanded because people are using more dollars for every transaction. Eventually, a new equilibrium at which the quantity of money demanded again equals the quantity of money supplied. The Classical Dichotomy and Monetary Neutrality David Hume suggests that economic variable should be divided into two groups:
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1. Nominal variables- variables measured in monetary units (farmer’s income) 2. Real variables- variables measured in physical units (quantity of corn produced) Classical dichotomy-the theoretical separation of nominal and real variables. ) (While dollar prices are nominal variables, relative prices are real variables. According to classical analysis, nominal variables are influences by developments in the eco- nomy’s monetary system, whereas money is largely irrelevant for explaining real variables. Monetary neutrality- the proposition that changes in the money supply do not affect real vari
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Chapter 17 Money Growth and Inflation - Chapter 17 Money...

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