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MACROECONOMICS © 2011 Worth Publishers, all rights reserved S E V E N T H E D I T I O N PowerPoint ® Slides by Ron Cronovich N. Gregory Mankiw C H A P.

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Presentation on theme: "MACROECONOMICS © 2011 Worth Publishers, all rights reserved S E V E N T H E D I T I O N PowerPoint ® Slides by Ron Cronovich N. Gregory Mankiw C H A P."— Presentation transcript:

1 MACROECONOMICS © 2011 Worth Publishers, all rights reserved S E V E N T H E D I T I O N PowerPoint ® Slides by Ron Cronovich N. Gregory Mankiw C H A P T E R Money and Inflation (edited by L Lamb, 2011) U P D A T E

2 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

3 2 CHAPTER 4 Money and Inflation 4.1 Money: Definition Money is the stock of assets that can be readily used to make transactions. What are the functions of money?

4 3 CHAPTER 4 Money and Inflation The central bank  Monetary policy is conducted by a country’s central bank.  In the Canada, the central bank is called the Bank of Canada

5 4 CHAPTER 4 Money and Inflation

6 5 4.2 Quantity Theory of Money  The quantity equation M  V = P  Y follows from the preceding definition of velocity.  It is an identity: it holds by definition of the variables.

7 International data on inflation and money growth Inflation rate (percent, logarithmic scale) Money supply growth (percent, logarithmic scale) Singapore Ecuador Turkey Belarus Argentina Indonesia

8 U.S. inflation and money growth, M2 growth rate inflation rate

9 U.S. inflation and money growth, Inflation and money growth have the same long-run trends, as the Quantity Theory predicts.

10 9 CHAPTER 4 Money and Inflation 4.3 Seigniorage  To spend more without raising taxes or selling bonds, the govt can print money.  The “revenue” raised from printing money is called seigniorage.

11 10 CHAPTER 4 Money and Inflation 4.4 Inflation and interest rates  Nominal interest rate, i not adjusted for inflation  Real interest rate, r adjusted for inflation: r = i  

12 11 CHAPTER 4 Money and Inflation Figure 4.3 Inflation and Nominal Interest Rates Over Time Mankiw and Scarth: Macroeconomics, Canadian Fourth Edition Copyright © 2011 by Worth Publishers

13 Inflation and nominal interest rates across countries Nominal interest rate (percent, logarithmic scale) Inflation rate (percent, logarithmic scale) Zimbabwe Romania Turkey Brazil Israel U.S. Germany Ethiopia Kenya Georgia

14 13 CHAPTER 4 Money and Inflation 4.5 Money demand and the nominal interest rate  In the quantity theory of money, the demand for real money balances depends only on real income Y.  Another determinant of money demand: the nominal interest rate, i.

15 14 CHAPTER 4 Money and Inflation 4.6 The social costs of inflation …fall into two categories: 1. costs when inflation is expected 2. costs when inflation is different than people had expected

16 15 CHAPTER 4 Money and Inflation The costs of expected inflation: 1. Shoeleather cost  def: the costs and inconveniences of reducing money balances to avoid the inflation tax.

17 16 CHAPTER 4 Money and Inflation The costs of expected inflation: 2. Menu costs  def: The costs of changing prices.

18 17 CHAPTER 4 Money and Inflation The costs of expected inflation: 3. Relative price distortions  Firms facing menu costs change prices infrequently.

19 18 CHAPTER 4 Money and Inflation The costs of expected inflation: 4. Unfair tax treatment Some taxes are not adjusted to account for inflation, such as the capital gains tax.

20 19 CHAPTER 4 Money and Inflation The costs of expected inflation: 5. General inconvenience  Inflation makes it harder to compare nominal values from different time periods.  This complicates long-range financial planning.

21 20 CHAPTER 4 Money and Inflation Additional cost of unexpected inflation: Arbitrary redistribution of purchasing power  Many long-term contracts not indexed, but based on E .

22 21 CHAPTER 4 Money and Inflation Additional cost of high inflation: Increased uncertainty  When inflation is high, it’s more variable and unpredictable.

23 22 CHAPTER 4 Money and Inflation One benefit of inflation  Moderate inflation improves the functioning of labor markets.

24 23 CHAPTER 4 Money and Inflation Hyperinflation  Common definition:   50% per month

25 A few examples of hyperinflation countryperiod CPI Inflation % per year M2 Growth % per year Israel %305% Brazil %1451% Bolivia %1727% Ukraine %1029% Argentina %1583% Dem. Republic of Congo / Zaire %2373% Angola %4106% Peru %3517% Zimbabwe %9914%

26 25 CHAPTER 4 Money and Inflation The Classical Dichotomy  Note: Real variables were explained in Chap 3, nominal ones in Chapter 4.  Classical dichotomy: the theoretical separation of real and nominal variables in the classical model, which implies nominal variables do not affect real variables.  Neutrality of money: Changes in the money supply do not affect real variables. In the real world, money is approximately neutral in the long run.


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