1、Questions What do economists mean by“money”?Why is money useful?What do economists mean when they say that money is a unit of account?What determines the price level and the inflation rate?1Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Questions Why would a government ever gene
2、rate“hyperinflation”?What determines the level of money demand?What determines the level of the money supply?Why is inflation seen as something to be avoided?2Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Inflation In the 1970s,the United States experienced an episode of relati
3、vely mild inflationprices rose between five and ten percent per yearcaused significant economic and political trauma avoiding a repeat of the inflation of the 1970s remains a major goal of economic policy3Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 8.1-Post-World War I
4、I Inflation in the United States,1951-20004Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Flexible-Price Model The Classical dichotomy implies that real variables(real GDP,real investment spending,or the real exchange rate)can be analyzed and calculated without considering n
5、ominal variables(price level)money is“neutral”This is a special feature of the full-employment flexible-price model5Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Money is wealth that is held in a readily-spendable form is made up ofcoin and currencychecking account balancesothe
6、r assets that can be turned into cash or demand deposits nearly instantaneously,without risk or cost6Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Usefulness of Money Without money,market transactions would have to be performed through barter In a barter economy,market exch
7、ange would require the coincidence of wantsyou would have to have some good or service that someone wants and he or she would have to have some good or service that you want7Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 8.2-Coincidence of Wants8Copyright 2002 by The McGr
8、aw-Hill Companies,Inc.All rights reserved.The Usefulness of Money Money also serves as a unit of accountmoney is used as a yardstick to measure value or quote prices Anything that alters the real value of money in terms of its purchasing power will also alter the real terms of existing contracts tha
9、t use the money as a unit of account9Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Demand for Money Businesses and households have a demand for moneythey want to hold a certain amount of wealth in the form of readily-spendable purchasing power to carry out transactions a hi
10、gher level of spending means a larger money demand There is a cost of holding moneycash and checking deposits earn little or no interest10Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 8.3-Reasons for and Opportunity Cost of Holding Money11Copyright 2002 by The McGraw-Hil
11、l Companies,Inc.All rights reserved.The Quantity Theory of Money assumes that the only important determinant of the demand for money is the flow of spending can be summarized usingthe Cambridge money-demand functionthe quantity equationY)(PV1MYPVM12Copyright 2002 by The McGraw-Hill Companies,Inc.All
12、 rights reserved.The Quantity Theory of Money(P Y)represents the total nominal flow of spending M is the quantity of money V is a measure of how fast money moves through the economyhow many times the average unit of money is used to buy a final good or serviceYPVM13Copyright 2002 by The McGraw-Hill
13、Companies,Inc.All rights reserved.Figure 8.4-The Velocity of Money14Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Determining the Price Level In the flexible-price model of the macroeconomyreal GDP(Y)is equal to potential GDP(Y*)the velocity of money is determined by the sophis
14、tication of the banking systemthe money supply is determined by the central bankMYVP15Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Determining the Price Level If the price level is higher than the quantity equation predictshouseholds and businesses will have less wealth in the
15、 form of money than they wish they will cut back on purchasessellers will note demand is weak and lower pricesMYVP16Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Determining the Price Level If the price level is lower than the quantity equation predictshouseholds and businesses
16、 will have more wealth in the form of money than they wish they will increase purchasessellers will note demand is strong and raise pricesMYVP17Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Determining the Price Level Example(third quarter of 1998)real GDP=$7,566 billionmoney s
17、tock=$1,072 billionvelocity=7.9641.1284$1,072$7,5567.964MYVP In the third quarter of 1998,the price level was equal to 112.84%of its 1992 level18Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Money Stock The Federal Reserve determines the money stock in the U.S.the determina
18、tion of the money stock is the basic task of monetary policy The Federal Reserve can directly impact the monetary basethe sum of currency in circulation and deposits at the Federal Reserves twelve branches19Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Money Stock To reduce
19、 the monetary base,the Federal Reserve sells short-term government securities To increase the monetary base,the Federal Reserve buys short-term government securities These transactions are called open market operations20Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 8.5-O
20、pen Market Operations21Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Money Stock The Federal Reserve directly controls the monetary base The other measures of the money stock are determined by the interaction of the monetary base with the banking sectorregulatory requiremen
21、tsthe incentive of financial institutions to have enough funds on hand to satisfy depositors demands22Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Money Stock Besides the monetary base(H),there are other definitions of the money stock such asM1(currency,checking accounts,t
22、ravelers checks)M2(M1 plus savings accounts,small term deposits,money held in money market accounts)M3(M2 plus large term deposits and institutional money market balances)23Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Table 8.1-Measures of the Money Stock24Copyright 2002 by Th
23、e McGraw-Hill Companies,Inc.All rights reserved.Inflation The inflation rate is the proportional rate of change in the price level Since the inflation rate()will beMYVPy-mv v=growth rate of velocitym=growth rate of the money stocky=growth rate of real GDP25Copyright 2002 by The McGraw-Hill Companies
24、,Inc.All rights reserved.Inflation Examplegrowth rate of real GDP=4%per yeargrowth rate of velocity=2%per yeargrowth rate of the money stock=5%per year3%4%-5%2%y-mv26Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Inflation The bulk of changes in the rate of inflation are due to
25、changes in the growth rate of the money stockthe growth rate of the money stock(m)can change quickly and substantiallychanges in the growth rates of real GDP(y)and velocity(v)are generally smaller27Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Inflation In the real world,inflat
26、ion is not always proportional to money growthin the 1980s,both inflation and velocity fell sharply but the money stock grewin the first half of the 1990s,velocity fell meant that high growth of the money stock did not lead to high inflationin the second half of the 1990s,velocity grew money supply
27、growth was negative to keep inflation from rising28Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 8.6-Money Growth and Inflation Are Not Always Parallel29Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Money Demand Economic theory implies that money de
28、mand should be inversely related to the nominal interest ratecash and checking account balances earn little or no interestthe purchasing power of money erodes at the rate of inflationthe expected real return on money is-e30Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Money Dem
29、and The opportunity cost of holding money is the difference between the rate of return on other assets(r)and the rate of return on money(-e)the opportunity cost of holding money is the nominal interest rate i=r+e As the opportunity cost of holding money(i)rises,the quantity of money balances demande
30、d falls31Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 8.7-Money Demand and theInflation Rate32Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Money Demand The velocity of money can be represented byVL represents the financial technology-driven trend
31、in velocityV0+Vi(r+e)represents the dependence of the demand for money on the nominal interest rate)(rVVVVei0L33Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Money Demand The demand for nominal money balances is)(rVVVYPMei0L34Copyright 2002 by The McGraw-Hill Companies,Inc.All
32、rights reserved.Money,Prices,and Inflation Suppose that the rate of growth of the money stock permanently increasesthe inflation rate will riseif the real interest rate is stable,the opportunity cost of holding money will risethe velocity of money will increaseif the money stock and real GDP remain
33、fixed,the price level will jump suddenly and discontinuously35Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 8.8-Effects of a Rise in Money Growth36Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Costs of Inflation The costs of expected inflation a
34、re smallrequires you to make more trips to the bankfirms must spend resources changing their priceshouseholds find it difficult to determine a good deal from a bad oneour tax laws are not designed to deal well with inflation37Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Co
35、sts of Inflation The costs of unexpected inflation are more significantredistributes wealth from creditors to debtors creditors receive less purchasing power than they had anticipated debtors find the payments they must make less burdensome than they had expected38Copyright 2002 by The McGraw-Hill C
36、ompanies,Inc.All rights reserved.Hyperinflation occurs when inflation rises to more than 20 percent per month arises when governments attempt to obtain extra revenue by printing moneyfinancing its spending by levying a tax on holdings of cashknown as an inflation tax39Copyright 2002 by The McGraw-Hi
37、ll Companies,Inc.All rights reserved.Figure 8.9-The Inflation Tax40Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Hyperinflation Eventually prices rise so rapidly that the monetary system breaks downpeople would rather deal in barter terms Real GDP begins to fallthe economy lose
38、s the benefits of the division of labor In the end,the currency becomes worthless41Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary By“money”economists mean something special:wealth in the form of readily-spendable purchasing power Without money it is hard to imagi
39、ne how our economy could successfully functionthe fact that everyone will accept money as payment for goods and services is necessary for the market economy to function42Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary Money is not only a medium of exchange,it is a
40、lso a unit of account:a yardstick that we use to measure values and to specify contracts43Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary Money demand is determined bybusinesses and households desire to hold wealth in the form of readily-spendable purchasing power
41、 to carry out transactionsbusinesses and households recognition that there is a cost to holding money wealth in the form of readily-spendable purchasing power pays little or no interest44Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary The velocity of money is how
42、many transactions a given piece of money manages to facilitate in a yearthe principal determinant of velocity is the economys“transactions technology”The stock of money is determined by the central bankthe Federal Reserve in the U.S.45Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserv
43、ed.Chapter Summary The price level is equal to the money stock times the velocity of money divided by the level of real GDP The inflation rate is equal to the proportional growth rate of the money stock plus the proportional growth rate of velocity minus the proportional growth rate of real GDP46Cop
44、yright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary Governments cause hyperinflation because printing money is a way of taxing the public,and a government that cannot tax any other way will be strongly tempted to resort to it47Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.
