Chapter 8 - 8.1 Introduction In this chapter, we learn:...

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1 Chapter 8 Inflation Charles I. Jones 8.1 Introduction • In this chapter, we learn: – what inflation is, and how costly it can be. – how the quantity theory of money and the classical dichotomy help us understand inflation inflation. – the relationship of interest rates and inflation through the Fisher equation. – the important link between fiscal policy and high inflation. • Inflation – the percentage change in an economy’s overall price level • Hyperinflation – an episode of extremely high inflation, – greater than 500 percent per year. – Example: Post WWI Germany • The inflation rate is computed a percentage change in the price level Price level in • The Consumer Price Index (CPI) – price index for a bundle of consumer goods. Price level in year t Case Study: How Much Is That? • We can use the CPI to evaluate the value of a good in 1950 in today’s dollars.
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2 • Multiply the price of the good in 1950 times the ratio of the CPI in today’s dollars to the CPI in 1950 dollars. • Not as large of a difference as the raw numbers may lead you to believe. • Other price indexes – the CPI excluding food and energy prices – the GDP deflator. 8.2 The Quantity Theory of Money • We often think of money as paper currency. Historically • Historically – money was backed by gold or silver • Today – currency is “fiat money” paper that the government simply declares 8.2 The Quantity Theory of Money – paper that the government simply declares is worth a certain price. – Money has value because we expect others will value it. Measures of the Money Supply • The monetary base includes currency and accounts, called reserves private banks hold accounts with the – private banks hold accounts with the economy’s central bank, which pay no interest. – ensure that banks have sufficient cash on hand in case of money withdrawals • Other measures of currency: –M1 • adds demand deposits to the money base. M2 – M2 • adds savings accounts and money market account balances to M1.
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3 Case Study: Digital Cash • Electronic forms of currency debit cards PayPal travelers’ checks – debit cards, PayPal, travelers checks – makes up most money in advanced economies The Quantity Equation • The quantity theory of money allows us to make the connection between money and inflation. Price
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This note was uploaded on 08/23/2011 for the course ECON 3203 taught by Professor Robertpennington during the Summer '11 term at University of Central Florida.

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Chapter 8 - 8.1 Introduction In this chapter, we learn:...

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