321LecNote08Ch4 - Instructor Kim H.H Fall 2009 Intermediate...

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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 1 Chapter 4. Money and Inflation In this chapter, you will learn: The classical theory of inflation causes effects social costs “Classical” – assumes prices are flexible & markets clear Applies to the long run Inflation and its trend, 1960-2009
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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 2 The connection between money and prices Inflation rate = _____________________________________________________________ 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. Money: Definition Money is the ______________ that can be readily used to make transactions. Money: Functions __________________________ we use it to buy stuff __________________________ transfers purchasing power from the present to the future __________________________ the common unit by which everyone measures prices and values Money: Types 1. __________________________ has no intrinsic value example: the paper currency we use 2. __________________________ has intrinsic value examples: gold coins, cigarettes in P.O.W. camps NOW YOU TRY: Discussion Question Which of these are money? a. Currency b. Checks c. Deposits in checking accounts (“demand deposits”)
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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 3 d. Credit cards e. Certificates of deposit (“time deposits”) The money supply and monetary policy definitions The __________________ is the quantity of money available in the economy. _______________ is the control over the money supply. The central bank Monetary policy is conducted by a country’s central bank . In the U.S., the central bank is called the __________________________ Money supply measures, May 2009 The Quantity Theory of Money A simple theory linking the inflation rate to the growth rate of the money supply. Begins with the concept of velocity Velocity basic concept: _____________________________________ definition: the number of times the average dollar bill changes hands in a given time period $8328 M1 + small time deposits, savings deposits, money market mutual funds, money market deposit accounts M2 $1596 C + demand deposits, travelers’ checks, other checkable deposits M1 $850 Currency C amount ($ billions) assets included symbol
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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 4 example: In 2009, $500 billion in transactions money supply = $100 billion The average dollar is used in five transactions in 2009 So, velocity = ? This suggests the following definition: where V = velocity T = value of all transactions M = money supply Use nominal GDP as a proxy for total transactions. Then, where = price of output (GDP deflator) = quantity of output (real GDP) = value of output (nominal GDP) The quantity equation The quantity equation __________________________ follows from the preceding definition of velocity. It is an identity: it holds by definition of the variables.
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