MONEY GROWTH AND INFLATION CH30 OVERVIEWS 1. The quantity theory of money •Money supply, inflation, and the value of money •The classical dichotomy and monetary neutrality •Quantity equation •Two applications: Hyperinflation and Fisher effect 2. The cost of inflation INFLATION – 1 Deflation 物价下降通貨緊縮 Decrease in the overall level of prices Average level of prices in the U.S. economy was 23% lower in 1896 than in 1880 Inflation 物价上漲通膨 Increase in the overall level of prices Substantial variation over time: 2008 – 2018: average rate of 1.5% per year 1970s: average rate of 7.8% per year. INFLATION – 2 2018, inflation rates: 2.4 percent in the United States 1.2 percent in Japan 4.8 percent in Mexico 12 percent in Nigeria 15 percent in Turkey 32 percent in Argentina 1.4 million percent per year in Venezuela Hyperinflation 惡性通膨 , An extraordinarily high rate of inflation 貨幣數量說 THE CLASSICAL THEORY OF INFLATION Prices rise when the government prints too much money. Most economists rely on the quantity theory of money to explain long-run determinants of the price level and the inflation rate Asserts that the quantity of money determines the value of money 主張貨幣數量決定貨幣价值 We study this theory using two approaches: 1. A supply-demand diagram 2. An equation THE LEVEL OF PRICES AND THE VALUE OF MONEY 物价 倒 數 关 係 , Price level, P: Number of dollars needed to buy a basket of goods and services When the price level rises, people have to pay more for the goods and services they buy. ( 貨幣价值 Value of money, 1/P: The quantity of goods and services that can be bought with $1 A rise in the price level: lower value of money because each dollar in your wallet now buys a smaller quantity of goods and services. Inflation drives up prices and drives down the value of money. THE MONEY SUPPLY-DEMAND DIAGRAM – 1 Value of Money, 1/P (High) 1 Price Level, P As the value of money rises, the price level falls. (Low) 1 ¾ 1.33 ½ 2 ¼ 4 (Low) (High) Quantity of Money MONEY SUPPLY ( MS) Money supply in the real world Determined by the Fed, the banking system, and consumers. Money supply in this model We assume the Fed precisely controls MS and sets it at some fixed amount. Ex. MS=$1000 THE MONEY SUPPLY-DEMAND DIAGRAM – 2 Value of Money, 1/P (High) Price Level, P Money Supply (Low) MS1 1 1 ¾ 1.33 The Fed sets MS at some fixed value, regardless of P. ½ ¼ (Low) 2 4 (High) $1,000 Quantity of Money MONEY DEMAND ( MD) 取 Money demand How much wealth people want to hold in liquid form Depends on P: an increase in P reduces the value of money, so more money is required to buy goods and services. Quantity of money demanded Is negatively related to the value of money And positively related to P, other things equal. THE MONEY SUPPLY-DEMAND DIAGRAM – 3 Value of Money, 1/P (High) A fall in value of money (or increase in P) increases the quantity of money demanded: Price Level, P (Low) 1 1 ¾ 1.33 ½ 2 ¼ (Low) Money demand MD1 Quantity of Money 4 (High) THE EQUILIBRIUM PRICE LEVEL Value of Money, 1/P (High) 1 eq’m value of money MS1 P adjusts to equate quantity of money demanded with money supply. (Low) 1 1.33 ¾ ½ Price Level, P A ¼ 2 MD1 (Low) $1,000 Quantity of Money 4 (High) eq’m price level THE EFFECTS OF A MONETARY INJECTION Value of Money, 1/P (High) MS1 1 ¾ New eq’m value of money ½ A ¼ If the Fed MS2 increases the money supply. Then the value of money falls, and P rises. Price Level, P (Low) 1 1.33 2 貨幣供給 ↑ 造成物价上漲 → 通膨 - New 4 ⼆ B eq’m 4 price MD1 level $2,000 Quantity of Money × 100 通膨率 $1,000 % = lo0 1 2 . Initial efm A . Q p =Ʃ =$ 100 , , P1 = 2 Suppose the Fed increases the MSLeh open MS 右移⾄ MS . . - mke purchasd < An increase in Ms causes an excess supply of money 處理⼿中多餘貨幣 ⼈們 on goods and service / deposies / buybond Spend → Increased Kemand forgood & Service → 在 G & S 供給不變 → 、 it 3 - The of money demanded fuantiey P↑ untilB increase 2 4 Q =$ = , 2, 000 , THE QUANTITY THEORY OF MONEY Quantity theory of money A theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate 4 貨幣數量理論主張 以 — — — 貨幣數量決定物价⽔ 貨數量成長率決定物价⾓率幣 us THE CLASSICAL DICHOTOMY – 1 Classical dichotomy 古典⼆分法 The theoretical separation of nominal variables and real variables 貨幣的 名⽬變數 Nominal variables: measured in ______________ units. Monetary Nominal GDP, nominal interest rate (rate of return measured in $), nominal wage ($ per hour worked) 實体的物品 實際變數 Real variables: measured in ______________ units. physical Real GDP, real interest rate (measured in output), real wage (measured in output) EXAMPLE 1: REAL VS. NOMINAL WAGE 薪資 The nominal wage, W = $15/hour (the price of labor), and the price level, P = 5 (the price of goods and services, so it’s $5/unit of output). The real wage is the price of labor relative to the price of output. Calculate the real wage. Real wage = W / P = ($15/hour) / ($5/unit of output) = 3 units of output per hour EXAMPLE 2: THE PRICE AND RELATIVE PRICE OF A GOOD The price of a smartphone is $450 and the price of a pepperoni pizza is $10. What is the relative price of a smartphone? 相对的 The relative price of a good is the price of one good in terms of another. The relative price of a smartphone is: = P smartphone / P pizza = ($450/smartphone ) / ($10/pizza) = 45 pizzas per smartphone 每⼀⼿机可換多少 pizza THE CLASSICAL DICHOTOMY – 2 Classical dichotomy: 理論上分為 Theoretical separation of nominal and real variables Monetary developments affect nominal variables but not real variables: If central bank doubles the money supply: Then all nominal variables—including prices—will double But all real variables—including relative prices—will remain unchanged. THE NEUTRALITY OF MONEY – 1 貨幣中立性名⽬變數受貨幣影響 但實際變數不會 , Monetary neutrality: The proposition that changes in the money supply do not affect real variables Doubling money supply Causes all nominal prices to double What happens to relative prices? EXAMPLE 3: THE NEUTRALITY OF MONEY Initially, relative price of smartphones in terms of pizza is 𝑃 𝑜𝑓 𝑠𝑚𝑎𝑟𝑡𝑝ℎ𝑜𝑛𝑒 𝑃 𝑜𝑓𝑝𝑖𝑧𝑧𝑎 = $450/𝑠𝑚𝑎𝑟𝑡𝑝ℎ𝑜𝑛𝑒 $10/𝑝𝑖𝑧𝑧𝑎 = = 45 pizzas per smartphone If all prices double: 𝑃 𝑜𝑓 𝑠𝑚𝑎𝑟𝑡𝑝ℎ𝑜𝑛𝑒 𝑃 𝑜𝑓𝑝𝑖𝑧𝑧𝑎 = $900/𝑠𝑚𝑎𝑟𝑡𝑝ℎ𝑜𝑛𝑒 $20/𝑝𝑖𝑧𝑧𝑎 = = 45 pizzas per smartphone The relative price is unchanged. ACTIVE LEARNING 1: THE NEUTRALITY OF MONEY If the central bank doubles the money supply, what happens with the real wage and total employment? Doubling the money supply: Nominal wages double Price level doubles Real wage is W/P remains unchanged Quantity of labor supplied does not change Quantity of labor demanded does not change Total employment of labor does not change THE NEUTRALITY OF MONEY – 2 nentraliey Most economists believe The classical dichotomy and neutrality of money describe the economy in the long run. In later chapters We will see that monetary changes can have important short-run effects on real variables. QUANTITY EQUATION: THE VELOCITY OF MONEY 貨幣流通的速度 ( 貨幣轉⼿的速度) = The number of transation in which Velocity of money: the average dollar is used The rate at which money changes hands 1 Velocity formula: O ralab 器 V 交品德 , 繼龘鮮 Notation: P x Y = nominal GDP = (price level) x (real GDP) M = money supply V = velocity . - : ② oniomal EXAMPLE 4: THE VELOCITY OF MONEY Assume there is only one good in the economy, pizza. In 2019, money supply is $10,000, real GDP is 3,000 pizzas and the price of pizza is $10. What was the velocity of money? Y = real GDP = 3,000 pizzas P = price level = price of pizza = $10 P x Y= nominal GDP = value of pizzas = $30,000 Velocity, V = P × Y / M = nominal GDP / money supply = $30,000/$10,000 = 3 The average dollar was used in 3 transactions. 平均⼀元可⽤來作交易 3 次 ( 被使⽤幾次) , U.S. NOMINAL GDP, M2, AND VELOCITY 1960–2019 穩定的 Velocity is fairly stable over the long run ⼀ ⼀ ( constelan 1960=100 不變的 M2 Nominal GDP Velocity 。 THE QUANTITY EQUATION 不變 时 时 AK . L . NH The quantity equation: M x V = P x 。 Y 不變 Relates the quantity of money (M) to the nominal value of output (P × Y) Shows that an increase in the quantity of money in an economy must be reflected in one of the other three variables: The price level must rise The quantity of output must rise Or the velocity of money must fall THE QUANTITY THEORY OF MONEY 1. V is relatively stable over time. 2. A change in M does not affect Y: money is neutral, Y is real GDP determined by technology & resources 不會被影響 3. A change in M causes nominal GDP (P x Y) to change by 就繼動多少 PY (NominalGD the same percentage. 回貨幣變動多少 p— 中企的 — — 明也 動多少被影響 So, P changes by same percentage as P x Y and M. 5. Rapid money supply growth causes rapid inflation. 𧖣 4. —— ACTIVE LEARNING 3: QUANTITY THEORY OF MONEY Assume there is only one good in the economy, corn. The economy has enough labor, capital, and land to produce 1,800 bushels of corn. 不變的 V is constant. In 2019, money supply was $3,600 and the price of corn was $8/bushel. For 2020, the Fed increases MS by 10%. A. Compute the velocity of money using 2019 information. B. Compute the 2020 values of nominal GDP and P. Compute the inflation rate for 2019–2020. C. Suppose tech. progress causes Y to increase to 1,950 in 2020. Compute the 2019–2020 inflation rate. 2019 A Y = V = 202 O B . M = MV P - × 1800 . M = 3600 ( 1 PY 3960 → 1800 3960 = , 3600 = 器 81800 Inflation C M . . = %) 10 + × 4 = = = 8 8 8 4 3960 NominalGDP 15840 P 15840 = P = 8. ( 貨幣增加 10 % - . = 8 V 4 = MV PY → 3960 = Y . × 4 = = = . Inflation 3 100 ⼈ = 10 % # 物價也增加 1950 P × 1950 1÷ 8 → 8 8 × 100 % = 1 . 54 % . 123 , 10 % ) inflation money growth If real GDP is constant If real GDP is growthrate growing inflation money " ' , = ; Economic growthincrease number of Money growth is needed for those rate transations lhtrd transations , THE FISHER EFFECT – 1 Principle of monetary neutrality An increase in the rate of money growth raises the rate of inflation but does not affect any real variable Because Real interest rate = Nominal interest rate – Inflation rate We get π π A Nominal interest rate = Real interest rate + Inflation rate 。 r = ⼼ π G — 由可貸資⾦市場決定 - THE FISHER EFFECT – 2 費雪效果 名⾃利率隨物价通 ”, 率⼀对⼀調整 Fisher effect One-for-one adjustment of nominal interest rate to inflation rate When the Fed increases the rate of money growth, the long-run result is: Higher inflation rate Higher nominal interest rate : U.S. NOMINAL INTEREST & INFLATION RATES, 1960–2019 Nominal interest rate Inflation rate The close relation between these variables is evidence for the Fisher effect. THE INFLATION TAX The inflation tax Revenue the government raises by creating (printing) money Like a tax on everyone who holds money When the government prints money The price level rises The dollars in your wallet are less valuable In the U.S., the inflation tax today accounts for less than 3% of total revenue