Money and GDP Let’s Roll

Gross Domestic Product GDP = total final transactions = the total value of goods & services purchased GDP = total final transactions = the total value of goods & services purchased Nominal GDP (Y) keeps current prices as they are and therefore contains inflation Nominal GDP (Y) keeps current prices as they are and therefore contains inflation Real GDP (y) keeps prices constant at some level and therefore records only output and its changes Real GDP (y) keeps prices constant at some level and therefore records only output and its changes But Y = Py (P = the price level). But Y = Py (P = the price level).

Money & Velocity Velocity (V) of circulation = the average number of times a currency unit gets spent per time period Velocity (V) of circulation = the average number of times a currency unit gets spent per time period If the money stock = $1000 and average velocity = 6, the money stock finances $6000 in spending during the year If the money stock = $1000 and average velocity = 6, the money stock finances $6000 in spending during the year

More of the Same MV = $1000*6 = $6000 = total amount of money spent MV = $1000*6 = $6000 = total amount of money spent M includes dollars that never get spent (in a piggy bank or safe deposit box) as well as dollars that get spent very often M includes dollars that never get spent (in a piggy bank or safe deposit box) as well as dollars that get spent very often Some dollars do a lot of work; others just sit somewhere Some dollars do a lot of work; others just sit somewhere Kind of like people Kind of like people

Velocity and Vacations Even hard working dollars get some time off Even hard working dollars get some time off If V = 6 per year, the average dollar relaxes two months between jobs in the market If V = 6 per year, the average dollar relaxes two months between jobs in the market Where do they take their vacations? In pockets, purses, bank accounts; all of the above Where do they take their vacations? In pockets, purses, bank accounts; all of the above

A Useful Equation If MV = total money spent per year, If MV = total money spent per year, Py = Y = total GDP purchased in the year; since total spending = total sales, then Py = Y = total GDP purchased in the year; since total spending = total sales, then MV = Py MV = Py In accounting, double entry would assure that this is true In accounting, double entry would assure that this is true

MV = Py V can change, but normally very slowly V can change, but normally very slowly y can change but growth rates rarely get to 10% y can change but growth rates rarely get to 10% Because H => M, H => P Because H => M, H => P The central bank determines the price level The central bank determines the price level The central bank, or rapid changes in H & M are always the causes of inflation The central bank, or rapid changes in H & M are always the causes of inflation

Percentage Changes Mathematically, Mathematically, %  M + %  V = %  P + %  y But if V & y don’t change very much, %  V = %  y = 0, or almost Hence, %  M = %  P

But V & y are not constant y grows, sometimes very rapidly, and M must grow with it y grows, sometimes very rapidly, and M must grow with it V changes, sometimes abruptly, especially if there is danger of inflation V changes, sometimes abruptly, especially if there is danger of inflation We’ll take these matters up in the next slide show We’ll take these matters up in the next slide show