1 MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT Money and Prices 2 nd 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,

11-5 UK Inflation,

11-6 U.S. Prices,

11-7 G7 Inflation,

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 TrumpDonald 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 ( )

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

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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 Vault Accumulation Total Money $10 $100 $90 $19 $190 $71 $26.10 $261 Base Currency … … … $100 $1000 M1

11-20 Money Multiplier

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 (January 1922 =1)

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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 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 Seignorage Growth in Money Supply Inflation

11-29 US Inflation and Money Growth

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