ec3332-semI09Lec2-1 (1)

ec3332-semI09Lec2-1 (1) - Money and Banking I EC3332 Sem II...

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Money and Banking I EC3332 Sem II, 2009-2010 Lecture 2 ± Chapter 3:Money Growth and Inflation
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Inflation ± Inflation is a monetary phenomenon: generated by a growing money supply. ± How does inflation affect the allocation of resources? ± How does it affect welfare? ± Can the government raise revenue by printing money at a faster rate?
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Plan ± Part 1. Growing money supply. ± Part 2. Effects of inflation. ± Part 3. The inefficiency of inflation. ± Part 4. A growing economy. ± Part 5. Seigniorage.
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Part 1. Growing money supply.
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Zimbabwe (2008)
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Money supply growth ± Gross growth rate of money supply: z (3.1) ± If z = 1 the money supply is constant. ± This implies that (3.2) units of new fiat money are printed each period. M t = zM t 1 M t M t 1 = M t M t z = 1 1 z M t
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Money injection ± Money is injected via lump-sum transfers to each old person in every period t . ± The transfer is worth a t units of good, i.e. (3.3) a t = 1 1 z υ t M t N t 1 Real value of the money injection at time t. Number of old at time t.
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Helicopter Drop (Apocalypse Now)
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Captain Kilgore ± http://www.gonemovies.com/WWW/MyWe bFilms/Oorlog/ApocalypseKilgore1.asp
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Ben Bernanke as Capt. Kilgore
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Government budget constraint ± Eq. (3.3) : Government budget constraint. ± In general: ± In this case: ² T t =D t =0 ² G t : Gifts to old people 1 1 1 + + = + t t t t t t t t D D M M T iD G P expenditure interest taxes Government debt
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Individual budget constraints ± For young and old: ± The resulting budget line is now 1, 2, 1 1 1 (3.4) (3.5) tt t t t cm y a υ ++ + +≤ ≤+ 2, 1 1 11 (3.6) t cc y a υυ ⎛⎞ + ⎜⎟ ⎝⎠
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Part 2. Effects of inflation
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Equilibrium of the money market ± Supply = Demand => (3.7) ± Assume a stationary allocation: (3.8) ± The rate of return of fiat money is ( ) 1, tt t t M Nyc υ =− ( ) 1 t t t M = ( ) () 11 1 1 1 (3.9) t t t t t t Ny c MM M Mz M z M + ++ + == = =
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Effects of money growth ± If z > 1 : the value of money declines over time. ± The larger the value of z , the lower the rate of return on money. ± Money growth creates inflation. ± Why? More dollars bid for the same number of goods => The price of goods goes up.
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1942 (Dr Seuss)
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Inflation rate ± Rate of growth of the price level: (3.10) ± Price level changes according to (3.11) 1 1 1 1 1 1 1 1 = = = + + + z p p p t t t t t t t υ p t + 1 = z p t
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Budget Set with Monetary Growth ± The lifetime budget set: (3.12) c 1 + zc 2 y + za Future consumption discounted at the rate of return of money.
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ec3332-semI09Lec2-1 (1) - Money and Banking I EC3332 Sem II...

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