Chapter 31 !

Money Growth and Inflation

12.95 August 2012

15.25 April 2014

17.8% increase

CPI GDP Deflator

Measuring Inflation

Year General Index

Food and non -

alcoholic beverages

TobaccoClothing and

Footwear

Housing , Water,

Electricity, Gas, and

other fuels

Furnishings, household

equipment & Routine

household maintenance

Health TransportCommuni-

cationRecreation and Culture Education

Restaurants and Hotels

Miscellaneous goods and

services

2007 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

2008 106.1 113.7 105.1 101.0 108.5 103.2 103.2 97.0 98.1 97.7 110.3 103.2 101.6

2009 110.5 116.4 107.3 101.6 120.1 105.6 103.2 98.2 98.2 99.2 111.8 110.0 104.9

2010 114.7 120.8 119.2 101.1 129.2 107.0 103.3 99.7 97.7 97.2 113.2 113.8 110.1

2011 119.0 127.1 126.7 99.7 143.9 115.5 103.4 103.1 92.0 104.7 108.7 117.0 113.9

2012 122.4 132.9 141.3 103.3 148.7 117.5 105.6 108.3 92.1 104.5 110.2 121.7 117.8

% Chg 2.9% 4.6% 11.5% 3.6% 3.3% 1.7% 2.1% 5.0% 0.1% -0.2% 1.4% 4.0% 3.4%

InflationCOUNTRY RATESaudi Arabia 2.8%United States 1.1%Venezuela 57.3%Japan 1.5%Egypt 9.8%Russia 6.2%Spain -0.2%UAE 1.8%Greece -1.1%Iran 28.8%Syria 49.5%

Source: Trading Economics April 2014

Inflation

Source: Trading Economics April 2014

-15%

0%

15%

30%

45%

60%

Saudi Arabia United States Venezuela Japan Egypt Russia Spain UAE Greece Iran Syria

What determines the value of money?

supply and demand

David Hume 1711-1776

!

!

dichotomy “split in two”

!

nominal vs. real

measured in monetary units

Nominal variable

measured in physical units

Real variable

different effects

Short Run vs.

Long Run

Milton Friedman 1912-2006

!

!

Quantity Theory of

Money

Quantity Theory of Money

M x V = P x Y M = Money V = Velocity P = Prices

Y = Output

Quantity Theory of Money

MV = PY Assume V is constant

then an increase in M will only increase P or Y

Quantity Theory of Money

MV = PY Increasing M will either

increase prices or output or both

Quantity Theory of Money

1. V is constant 2. Change M will change P x Y 3. Y is a function of capital 4. If M is increased then P is increased 5. Therefore increasing M will increase inflation

Government Spending

tax borrow

print

Inflation Tax

When government prints too much money is

becomes less valuable. Anyone who has money

has lost value

Real vs. Nominal

Real Interest Rate = Nominal Rate + Inflation

Rate !

R = N + I

Real vs. Nominal

Real = Nominal - Inflation !

Nominal = Real + Inflation !

Inflation = Nominal - Real !

Indexing

Adjusting nominal rate for inflation

Year NOMINAL OIL PRICE

REAL OIL PRICE

Base Year 20051970 1.30 5.35 411.5%1971 1.65 6.46 391.5%1972 1.90 7.13 375.3%1973 2.70 9.61 355.9%1974 9.76 31.83 326.1%1975 10.72 31.94 297.9%1976 11.51 32.43 281.8%1977 12.40 32.85 264.9%1978 12.70 31.44 247.6%1979 17.26 39.44 228.5%1980 28.67 59.99 209.2%1981 34.23 65.49 191.3%1982 31.74 57.23 180.3%1983 28.77 49.90 173.4%1984 28.06 46.91 167.2%1985 27.54 44.69 162.3%1986 13.73 21.80 158.8%1987 17.23 26.58 154.3%1988 13.40 19.99 149.2%1989 16.21 23.30 143.7%1990 20.82 28.81 138.4%1991 17.43 23.29 133.6%1992 17.94 23.42 130.5%1993 15.68 20.03 127.7%1994 15.39 19.25 125.1%1995 16.73 20.50 122.5%1996 19.91 23.94 120.2%1997 18.71 22.11 118.2%1998 12.20 14.26 116.9%1999 17.45 20.09 115.1%2000 26.81 30.22 112.7%2001 23.06 25.42 110.2%2002 24.32 26.38 108.5%2003 27.69 29.42 106.2%2004 34.53 35.68 103.3%2005 50.15 50.15 100.0%2006 61.05 59.14 96.9%2007 68.75 64.72 94.1%2008 95.16 87.64 92.1%2009 61.38 56.04 91.3%2010 77.75 70.05 90.1%2011 107.80 95.10 88.2%2012 110.27 95.72 86.8%

0

25

50

75

100

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Real Oil Price Base year 2005

Three Tools of Central Banks

Open-Market Operations

Discount Rate

Reserve Ratio

What did SAMA do to fight the financial crisis in

2008?Dropped the ORR from 5.5%

to 2.0%

Dropped the Reserve Ratio from 13 percent to 7 percent

SAMA Official Repo Rate

Dropped from 5.5% October 2008

to 2.0% by January 2009 3 month period of

global financial crisis Rate increased

as economy heated up

Inflation Deflation

Winners Borrowers Lenders

Losers Lenders Borrowers