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MACROECONOMICSAND THE GLOBAL BUSINESS ENVIRONMENT

Money and Prices

2nd edition

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Key Concepts

Inflation Hyperinflation Inflation Tax and Seignorage

Monetarism Money Neutrality Quantity Theory

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Inflation

The rate of change in the price level

Rate of Inflation = P(1) – P(0)

P(0)

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UK Prices, 1661 - 1991

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UK Inflation, 1661 - 1999

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U.S. Prices, 1800 - 2000

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G7 Inflation, 1975 - 2000

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0

5

10

15

20

25

30

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999Canada

USA

France

Germany

Italy

Japan

UK

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Measuring Inflation

Consumer Price Index (CPI) Producers’ Price Index (PPI) GDP Deflator

Ratio of Nominal GDP to Real GDP Mis-measurement issues

Substitution Quality

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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?

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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

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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

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Money

Money was never a big motivation for me, except as a way to keep score. The real excitement is playing the game.

Donald 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 (1896 - 1969)

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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

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Money

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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

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Monetary Aggregates, (Billions $)

Source: Board of Governors On-line Statistics

M3

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Money Multiplier

$100$100

Vault Accumulation

Total Money

$10$10

$100$100

$90$90

$19$19

$190$190

$71$71

$26.10$26.10

$261$261

Base Currency

…

…

… $100$100

$1000$1000

M1

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Money Multiplier

Deposits Needed Reserves (10%) Lend Out

$1,000,000 $100,000 $900,000

900,000 90,000 810,000

810,000 81,000 729,000

729,000 72,900 656,100

. . .

. . .

. . .

$10,000,000 $1,000,000 $9,000,000

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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

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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

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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

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The German hyperinflation 1922-23 (January 1922 =1)

Currency Prices Real Money

Inflation (% per month)

Jan 1922 1 1 1.00 5

Jan 1923 16 75 0.21 189

July 1923 354 2021 0.18 386

Sept 1923 227777 645946 0.35 2532

Oct 1923 20201256 191891890 0.11 29720

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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

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Quantity Theory

MV = PY

Inflation is always and everywhere monetary phenomenon.Milton Friedman

Velocity: the circulation rate of moneyVelocity: the circulation rate of money

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%M + %V = %P + %Y

Assume V = constant, so %V = 0 %M = %P + %Y

%Y determined by investment, technology, etc. %M is proportional to %P

SeignorageSeignorageGrowth in

Money Supply

Growth in Money Supply

InflationInflation

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US Inflation and Money Growth

1970s1910s

1940s

1900s1960s

1890s

1880s1870s1920s1930s

1950s1990s

1980s

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0

2

4

6

8

10

0 2 4 6 8 10 12

Money Supply Growth (%)

Infl

atio

n %

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UK Inflation and Money Growth

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Cross-country Inflation and Money Growth, Long Run

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Cross-country Inflation and Money Growth, Short Run

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Summary

Inflation Measures Costs Deflation

Money Definitions Multiplier Seignorage and Inflation Tax

Hyperinflation