Money and inflation

Money and inflation
• = asset regularly used to buy goods and
services from other people
• Liquidity
• Medium of exchange
• Unit account
• Store of value
• Wealth and money
• Medium of exchange (liquidity) vs. store of
Kind of money
• Commodity money (gold, silver, cigarettes):
Intrinsic value
• Fiat money: no intrinsic value
Usually decreed by government.
People have to accept such money, trust
Kind of money
• Currency
• Deposits
• Money aggregates:
M1: currency + demanded deposits
• M2: M1 + saving deposits + money market
mutual funds
Money and banking
Fractional-reserving banking
Reserve ratio
Minimal reserve ratio
Money multiplier = 1/reserve ratio
Money multiplies in „good“ and „bad“ times –
excessed reserve
• Liquidity trap
• Bank run
Money and banking
• Central bank operations:
- open market operations
- reserve requirements
- discount rate
Money supply and demand
• Supply: determined by central bank and
operations of commercial bank
• Demand: determined by willingness economic
subject (people, firm and other corporation)
to hold money. Depend on value of money.
Value of money
• = how much goods and
services is possible to
buy per a money unit.
Change of value of money
• If money amount
changes without change
of amount good and
services value of money
also changes.
Monetary neutrality
• Nominal variables: measured in monetary unit,
influenced by monetary system.
• Real variables: measured in physical units,
influenced by real factors (amount of labor,
capital, technology ….).
• Classical dichotomy: separation on nominal and
real variables.
• A change in money amount in long run does not
affect real variable. However, it does in short run.
Monetary neutrality and
quantity equation
• M*V=P*Y
• V = velocity of money,
sped how money unit is used.
• Expected to be stable or to change due to real
change (debit and credit card, internet banking).
• Y = amount of goods and services, determined by
real factors.
• Change of M (amount of money) results in
change of P (price level).
Nominal and real interest rate
• i = nominal rate, r = real rate, Π =rate of
inflation. All in decimal shape.
• (1 + i) = (1 + r) * (1 + Π)
• i = (1 + r) * (1 + Π) – 1
• r = (1 + i)/(1 + Π) - 1
Nominal and real interest rate
• For small value of inflation (till 5 – 10 %) the
approximate relationship:
• Fisher effect: the value of nominal interest
rate is determined (adjusted) by inflation rate.
• Money growth rate is higher that money
demand growth rate.
• Money demand growth rate is determined
mostly by real factor (real GDP, technological
progress, including progress affecting using of
money as internet banking).
• Inflation = money loose its value, it is possible
to buy less goods and services per money unit
=> inflation tax.
Examples of inflation
• Germany 1923:
• Zinbabwe 2008:
Costs of inflation
• Money loose their value – not used as store of
• Shoeleather costs.
• Menu costs.
• Relativity price variability and misallocation of
• Inflation-induced tax distortion.
• Confusion and inconvenience.
• Arbitrary redistribution of wealth.