1 macroeconomics and the global business environment money and prices 2 nd edition
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MACROECONOMICSAND THE GLOBAL BUSINESS ENVIRONMENT
Money and Prices
2nd edition
11-2
Key Concepts
Inflation Hyperinflation Inflation Tax and Seignorage
Monetarism Money Neutrality Quantity Theory
11-3
Inflation
The rate of change in the price level
Rate of Inflation = P(1) – P(0)
P(0)
11-4
UK Prices, 1661 - 1991
11-5
UK Inflation, 1661 - 1999
11-6
U.S. Prices, 1800 - 2000
11-7
G7 Inflation, 1975 - 2000
-5
0
5
10
15
20
25
30
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999Canada
USA
France
Germany
Italy
Japan
UK
11-8
Measuring Inflation
Consumer Price Index (CPI) Producers’ Price Index (PPI) GDP Deflator
Ratio of Nominal GDP to Real GDP Mis-measurement issues
Substitution Quality
11-9
Money Neutrality
Price level is a yardstick Nominal measure
Does it matter which unit we use? Double all prices and incomes Is your welfare the same, better, or worse?
11-10
Costs of Inflation
Tax system Bracket creep
Shoe Leather costs Menu costs
Transactions costs associated with changing prices Relative price issues
Price signal sends wrong message Unexpected inflation
Harms savers Effect on long-run growth
11-11
What about deflation?
Two types of deflation Demand-induced
Price uncertainty High ex-post real interest rates Real burden of debt
Unexpected deflation
Supply-induced
11-12
Money
Money was never a big motivation for me, except as a way to keep score. The real excitement is playing the game.
Donald Trump, "Trump: Art of the Deal"
Money is a terrible master but an excellent servant.
Phineas Taylor Barnum
A billion here, a billion there - pretty soon it adds up to real money.
Senator Everett Dirksen (1896 - 1969)
11-13
Money
Why money Eliminates double coincident of wants problem facing
barter economy Role of money
Store of value Medium of exchange Unit of account
Kinds of money Commodity Money Backed currency Fiat Currency
11-14
Money
11-15
11-16
11-17
The Money Supply
M1: Currency Checkable deposits (i.e. demand deposits) Traveler’s Checks
M2: M1 Savings and small time deposits (including
money market deposit accounts) Retail money market mutual funds
11-18
Monetary Aggregates, (Billions $)
Source: Board of Governors On-line Statistics
M3
11-19
Money Multiplier
$100$100
Vault Accumulation
Total Money
$10$10
$100$100
$90$90
$19$19
$190$190
$71$71
$26.10$26.10
$261$261
Base Currency
…
…
… $100$100
$1000$1000
M1
11-20
Money Multiplier
Deposits Needed Reserves (10%) Lend Out
$1,000,000 $100,000 $900,000
900,000 90,000 810,000
810,000 81,000 729,000
729,000 72,900 656,100
. . .
. . .
. . .
$10,000,000 $1,000,000 $9,000,000
11-21
Money Multiplier = 1/(reserve requirement)
Assumes banks don’t hold excess reserves Assumes loans make it back to bank as
deposits Assumes currency doesn’t leave country 3 parties that help determine money supply
Central bank Private banks Individuals
11-22
Seignorage
How does it work? Direct – print money Indirect – print money, buy and hold
government debt Inflation Tax
Decline in value of cash holdings due to inflation
Seignorage can be the same as the inflation tax
11-23
Hyperinflation
High and persistent rate of inflation Relationship to fiscal policy
Finance government. spending via inflation tax
Rising Inflation
People decrease money holdings by buying goods
Declining value of Money
11-24
The German hyperinflation 1922-23 (January 1922 =1)
Currency Prices Real Money
Inflation (% per month)
Jan 1922 1 1 1.00 5
Jan 1923 16 75 0.21 189
July 1923 354 2021 0.18 386
Sept 1923 227777 645946 0.35 2532
Oct 1923 20201256 191891890 0.11 29720
11-25
11-26
Further Examples
A 500,000,000,000 (500 billion) Yugoslav dinar banknote circa 1993 the largest nominal value ever officially printed in Yugoslavia.
A 200,000 and 500,000 German Mark coin from 1923
11-27
Quantity Theory
MV = PY
Inflation is always and everywhere monetary phenomenon.Milton Friedman
Velocity: the circulation rate of moneyVelocity: the circulation rate of money
11-28
%M + %V = %P + %Y
Assume V = constant, so %V = 0 %M = %P + %Y
%Y determined by investment, technology, etc. %M is proportional to %P
SeignorageSeignorageGrowth in
Money Supply
Growth in Money Supply
InflationInflation
11-29
US Inflation and Money Growth
1970s1910s
1940s
1900s1960s
1890s
1880s1870s1920s1930s
1950s1990s
1980s
-4
-2
0
2
4
6
8
10
0 2 4 6 8 10 12
Money Supply Growth (%)
Infl
atio
n %
11-30
UK Inflation and Money Growth
11-31
Cross-country Inflation and Money Growth, Long Run
11-32
Cross-country Inflation and Money Growth, Short Run
11-33
Summary
Inflation Measures Costs Deflation
Money Definitions Multiplier Seignorage and Inflation Tax
Hyperinflation