Money, Prices, and the Federal Reserve Principles of Macroeconomics Dr. Gabriel X. Martinez Ave...

Money, Prices, and the Federal ReserveMoney, Prices, and the Federal Reserve

Principles of Macroeconomics

Dr. Gabriel X. Martinez

Ave Maria University

Chapter 23: Money, Prices, and thChapter 23: Money, Prices, and the Federal Reservee Federal Reserve

22

IntroductionIntroduction

Is Economics about Money?Is Economics about Money?

What is Money?What is Money?


33

IntroductionIntroduction

MoneyMoney– Any asset that is generally accepted in making Any asset that is generally accepted in making

purchasespurchases– ExamplesExamples

Paper Currency, (worthless) Coins, and Checking Paper Currency, (worthless) Coins, and Checking AccountsAccounts

But alsoBut also– Bronze, Silver, and GoldBronze, Silver, and Gold– Cows, Clams, and Cocoa BeansCows, Clams, and Cocoa Beans– At different times and in different places, foreign currency, At different times and in different places, foreign currency,

boulders, even tulip bulbs have been accepted as money.boulders, even tulip bulbs have been accepted as money.


44

Money and Its UsesMoney and Its Uses

An asset is money if it is …An asset is money if it is … ……A Medium of ExchangeA Medium of Exchange

– If it is used in purchasing goods and services.If it is used in purchasing goods and services.

……A Unit of AccountA Unit of Account– If it is a basic measure of economic value.If it is a basic measure of economic value.

……A Store of ValueA Store of Value– If is serves as a means of holding wealth.If is serves as a means of holding wealth.


55


Why is barter inconvenient?Why is barter inconvenient?– Double coincidence of wants.Double coincidence of wants.

Would a bartender accept an economics lecture?Would a bartender accept an economics lecture?

– Less specializationLess specialization People try to do everything by themselves.People try to do everything by themselves.

How does money solve this problem?How does money solve this problem?– Why is everyone willing to accept money?Why is everyone willing to accept money?– What if people refuse to accept your “money”?What if people refuse to accept your “money”?


66


Is cash money?Is cash money? Are checking accounts money?Are checking accounts money? Are savings accounts money?Are savings accounts money? Are 3-month certificates of deposit money?Are 3-month certificates of deposit money? Are 1-year, negotiable, CDs money?Are 1-year, negotiable, CDs money? Is a gold mine money?Is a gold mine money? Is a house money?Is a house money?


99

How do non-cash assets that are also How do non-cash assets that are also money (e.g., checking accounts) come into money (e.g., checking accounts) come into existence?existence?

Commercial Banks and the Creation Commercial Banks and the Creation of Moneyof Money

Palazzo Ducale di Venetia


1010

Republic of VeniceRepublic of Venice– Central Bank issues 1 million guilders.Central Bank issues 1 million guilders.


Colonna di San Todaro

Basilica di San Marco

Colonna di San Marco

Source of pictures:

www.VeNETia.it


1111


People want to place their 1 million guilders People want to place their 1 million guilders in a bankin a bank

Why? Why do banks exist?Why? Why do banks exist?– They are safer than your pocket or couch.They are safer than your pocket or couch.– They are convenient (fund transfers, check-They are convenient (fund transfers, check-

writing).writing).– They may pay interest on your deposited funds.They may pay interest on your deposited funds.– They channel your savings to productive uses.They channel your savings to productive uses.


1212

AssetsCurrency 1,000,000 guilders

LiabilitiesDeposits 1,000,000 guilders

Central Bank issues 1 million guilders.Citizens open accounts and deposit

1 million guilders• Deposits are liabilities for the bank• The guilders are an asset for the bank

Consolidated Balance Sheet of Consolidated Balance Sheet of Venetian Commercial Banks (Initial)Venetian Commercial Banks (Initial)


1313

If a bank receives deposits If a bank receives deposits and keeps themand keeps them, , those guilders are the bank’s those guilders are the bank’s reservesreserves..

Bank ReservesBank Reserves– Cash or similar assets held by commercial Cash or similar assets held by commercial

banks for the purpose of meeting depositor banks for the purpose of meeting depositor withdrawals and paymentswithdrawals and payments

Suppose Suppose Reserves = deposits. Then we Reserves = deposits. Then we have 100% reserve banking.have 100% reserve banking.



1414

Why keep Reserves?Why keep Reserves?– Because if depositors want to withdraw some of Because if depositors want to withdraw some of

their funds, the bank their funds, the bank mustmust have cash available. have cash available. Why not keep 100% Reserves?Why not keep 100% Reserves?

– Because a bank’s business is to lend out funds Because a bank’s business is to lend out funds (i.e., its depositors’ savings).(i.e., its depositors’ savings).

How much should banks keep in Reserves?How much should banks keep in Reserves?– The Central Bank’s requirement,The Central Bank’s requirement,– plus plus predicted withdrawals.predicted withdrawals.



1515

Commercial Banks and the Creation of MoneyCommercial Banks and the Creation of Money

ReservesReserves DepositsDeposits Reserve/Deposit RatioReserve/Deposit Ratio

2020 200200

4040 200200

6060 200200

8080 200200

100100 200200

120120 200200

140140 200200

160160 200200

180180 200200

200200 200200


1616

Reserves are not part of the money supply Reserves are not part of the money supply (they cannot be used for exchange with (they cannot be used for exchange with goods/services).goods/services).

Deposits are part of the money supply (you Deposits are part of the money supply (you can write checks on your checking can write checks on your checking deposits).deposits).

Remember Remember checks checks are NOT money!are NOT money!


The Process of Deposit CreationThe Process of Deposit Creation


1818

AssetsCurrency 1,000,000 guilders


Central Bank issues 1 million guilders.Citizens open accounts and deposit

1 million guilders• Deposits are liabilities for the bank• The guilders are an asset for the bank

Consolidated Balance Sheet of Consolidated Balance Sheet of Venetian Commercial Banks (Initial)Venetian Commercial Banks (Initial)


1919

AssetsCurrency (= reserves) 100,000 guilders

Loans to farmers 900,000 guilders


Fractional Reserve Banking System• Bankers agree they only need a reserve to deposit ratio of 10%• R = r D = 0.1 D• Required reserves = 100,000 guilders, 10% of deposits

• Lend the excess reserves of 900,000 guilders


Consolidated Balance Sheet of Venetian Commercial BanksConsolidated Balance Sheet of Venetian Commercial BanksAfter One Round of LoansAfter One Round of Loans


2020

$Bank 1


Sourcehttp://www.dtsonline.com/media/img_investors.jpg


2121

$Bank 1

$Bank 2



2222

$Bank 1

$Bank 2

$Bank 3


2323

$Bank 1

$Bank 2

$Bank 3

$Bank 4


2424

$Bank 1

$Bank 2

$Bank 3

$Bank 4

1000

900

810

729

810

729

900


2525

900

+

Deposits

3439

810

+

729

Notice how the original deposit of 1000 has gotten multiplied.

Because Deposits are part of money, the money supply has grown by $3439

1000+


2626

AssetsCurrency (= reserves) 100,000 guilders

Loans to farmers 900,000 guilders


Fractional Reserve Banking System• Bankers agree they only need a reserve to deposit ratio of 10%• R = r D = 0.1 D• Required reserves = 100,000 guilders, 10% of deposits

• Lend the excess reserves of 900,000 guilders


Consolidated Balance Sheet of Venetian Commercial BanksConsolidated Balance Sheet of Venetian Commercial BanksAfter One Round of LoansAfter One Round of Loans


2727

AssetsCurrency (= reserves)

1,000,000 guilders

Loans to farmers

900,000 guilders


Loan proceeds are redeposited• Reserves = 100,000 + 900,000 = 1,000,000 guilders• Deposits = 1,900,000 guilders• Money supply = Deposits = 1,900,000 guilders• Excess reserves = Reserves – 0.1 * Deposits• Excess reserves = 1,000,000 – 0.1 * 1,900,000• Excess reserves = 1,000,000 – 190,000 = 810,000

• Banks can lend the excess 810,000 guilders

The Process of Deposit CreationThe Process of Deposit CreationConsolidated Balance Sheet of Venetian Commercial Banks Consolidated Balance Sheet of Venetian Commercial Banks

After One Round of LoansAfter One Round of Loans


2828


190,000 guilders

Loans to farmers

900,000 guilders

Loans to merchants

810,000 guilders


Lend excess reserves• Reserves = 190,000 guilders• Deposits = 1,900,000 guilders• Money supply = Deposits = 190,000 guilders• Loans = 900,000 + 810,000 = 1,710,000


Consolidated Balance Sheet of Venetian Commercial BanksConsolidated Balance Sheet of Venetian Commercial BanksAfter Two Rounds of Loans and RedepositsAfter Two Rounds of Loans and Redeposits


2929


1,000,000 guilders

Loans to farmers

900,000 guilders

Loans to merchants

810,000 guilders


Loan proceeds are redeposited• Reserves = 190,000 + 810,000 = 1,000,000 guilders• Deposits = 1,900,000 + 810,000 = 2,710,000 guilders• Money supply = Deposits = 2,710,000 guilders• Excess reserves = Reserves – 0.1 * Deposits• Excess reserves = 1,000,000 – 271,000 = 729,000• Excess reserves = 729,000 guilders


Consolidated Balance Sheet of Venetian Commercial BanksConsolidated Balance Sheet of Venetian Commercial BanksAfter Two Rounds of Loans and RedepositsAfter Two Rounds of Loans and Redeposits


3030

The Process of Deposit CreationThe Process of Deposit CreationDeposits Reserves Loans

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

656,100 65,610 590,490

590,490 59,049 531,441

531,441 53,144 478,297

478,296 47,830 430,467

10,000,000 1,000,000 9,000,000… … …

Notice Reserves = 10% of D

Also Reserves = original injection of Reserves by Central Bank =

1 millionD=10*R


3131

The Process of Deposit CreationThe Process of Deposit CreationDeposits Reserves Loans

1,000 100 900

900 900 810

810 81 729

729 72.9 656.1

656 65.61 590.49

590.49 59.05 531.44

531.44 53.14 478.30

478.30 47.83 430.47

10,000 1,000 9,000… … …

Notice Reserves = 10% of D

Also Reserves = original injection of Reserves by Central Bank =

1000D=10*R


3232


1,000,000 guilders

Loans to farmers

9,000,000 guilders


Observations• Lending will continue to keep the reserve to deposit ratio = 10%• When loans = 9,000,000 guilders

•Deposits = 10,000,000 guilders•Reserves = 1,000,000 guilders•Reserve to deposit ratio = 10%•No excess reserves

• The money supply = 10,000,000 guilders

The Process of Deposit CreationThe Process of Deposit CreationFinal Consolidated Balance Sheet of Venetian Commercial BanksFinal Consolidated Balance Sheet of Venetian Commercial Banks


3333

The use of a fractional-reserve banking system The use of a fractional-reserve banking system allows the money supply to grow as a multiple of allows the money supply to grow as a multiple of the reserves.the reserves.

In Venice, with a 10% reserve-deposit ratio,In Venice, with a 10% reserve-deposit ratio,1 guilder in reserve can support 10 guilders in 1 guilder in reserve can support 10 guilders in deposit.deposit.– The CB creates currency, which is kept by banks as The CB creates currency, which is kept by banks as

reserves. As long as banks have reserves, they can reserves. As long as banks have reserves, they can make loans, which are redeposited and become money.make loans, which are redeposited and become money.



3434

SummarySummary– R = r DR = r D– Bank reserves/bank deposits = desired reserve-Bank reserves/bank deposits = desired reserve-

deposit ratiodeposit ratio– R / D = rR / D = r– Bank deposits = bank reserves/desired reserve-Bank deposits = bank reserves/desired reserve-

deposit ratiodeposit ratio– D = R / rD = R / r



3535

The Central Bank can control the amount of The Central Bank can control the amount of money in an economy bymoney in an economy by– Printing more (or fewer) dollar bills.Printing more (or fewer) dollar bills.

It gives them out by exchanging them for government It gives them out by exchanging them for government bonds or by lending them to banks.bonds or by lending them to banks.

– Changing the reserve requirement ( Changing the reserve requirement ( rr ). ).



3636

Exercise 23.2Exercise 23.2

Suppose banks’ desired reserve/deposit ratio is Suppose banks’ desired reserve/deposit ratio is 10%, and the CB prints 1m guilders.10%, and the CB prints 1m guilders.

How does the money supply change?How does the money supply change?• Since we are still assuming people don’t hold currency, Since we are still assuming people don’t hold currency,

the 1m guilders the 1m guilders mustmust be held as reserves by the be held as reserves by the banking system.banking system.

• Without currency, money supply = deposits.Without currency, money supply = deposits.• Deposits = (1/r)*ReservesDeposits = (1/r)*Reserves• Deposits = (1/r)*Deposits = (1/r)*ReservesReserves• 10m = 10*1m = (1/0.10)*1m10m = 10*1m = (1/0.10)*1m


3737


Suppose banks’ desired reserve/deposit Suppose banks’ desired reserve/deposit ratio is 10%, and the CB prints 2m guilders.ratio is 10%, and the CB prints 2m guilders.

How does the money supply change?How does the money supply change?• Without currency, money supply = deposits.Without currency, money supply = deposits.• Deposits = (1/r)*ReservesDeposits = (1/r)*Reserves• Deposits = (1/r)*Deposits = (1/r)*ReservesReserves• 20m = 10*2m = (1/0.10)*2m20m = 10*2m = (1/0.10)*2m


3838


Suppose banks’ desired reserve/deposit Suppose banks’ desired reserve/deposit ratio is 5%, and the CB prints 1m guilders.ratio is 5%, and the CB prints 1m guilders.

How does the money supply change?How does the money supply change?• Deposits = (1/r)*ReservesDeposits = (1/r)*Reserves• Deposits = (1/r)*Deposits = (1/r)*ReservesReserves• 20m = 20*1m = (1/0.05)*1m20m = 20*1m = (1/0.05)*1m

Money Supply with Both Money Supply with Both Currency and DepositsCurrency and Deposits


4040

Money Supply = Currency + DepositsMoney Supply = Currency + Deposits

Money Supply = Currency + R / rMoney Supply = Currency + R / r

Currency + Reserves = Central Bank MoneyCurrency + Reserves = Central Bank Money

– If the Central Bank prints $1000, If the Central Bank prints $1000, all of it must be all of it must be heldheld either in Currency or in Reserves. either in Currency or in Reserves.



4141

The Money Supply with Both Currency and The Money Supply with Both Currency and DepositsDeposits– Suppose residents choose to hold 500,000 Suppose residents choose to hold 500,000

guilders as currencyguilders as currency– If the CB issues 1 million guilders, people If the CB issues 1 million guilders, people

deposit 500,000 in the banksdeposit 500,000 in the banks– Reserve-deposit ratio = 10%Reserve-deposit ratio = 10%– Bank deposits = 500,000/0.10 = 5,000,000Bank deposits = 500,000/0.10 = 5,000,000



4242

The Money Supply with Both Currency and The Money Supply with Both Currency and DepositsDeposits– Money supply = currency + bank deposits Money supply = currency + bank deposits

5,500,000 = 500,000 + 5,000,000 5,500,000 = 500,000 + 5,000,000 But before we found that currency = 0,But before we found that currency = 0,

10,000,000 = 0 + 10,000,00010,000,000 = 0 + 10,000,000

– The money supply is reduced by 4,500,000 The money supply is reduced by 4,500,000 guilders when the residents hold 500,000 guilders when the residents hold 500,000 guilders in currencyguilders in currency



4343

The Money Supply at ChristmasThe Money Supply at Christmas– Currency = 500Currency = 500– Bank reserves = 500Bank reserves = 500– Reserve-deposit ratio = 0.20Reserve-deposit ratio = 0.20– Money supplyMoney supply

= 500 + 500/.20= 500 + 500/.20= 500 + 2,500= 500 + 2,500= 3,000= 3,000



4444

The Money Supply at ChristmasThe Money Supply at Christmas– If Xmas shoppers withdraw 100If Xmas shoppers withdraw 100– Money supplyMoney supply

= (500+100) + (500 – 100)/0.20= (500+100) + (500 – 100)/0.20= 600 + 400/0.20= 600 + 400/0.20= 600 + 2,000= 600 + 2,000= 2,600= 2,600



4545

The Money Supply at ChristmasThe Money Supply at Christmas– ObservationObservation

When the reserve-deposit ratio = 0.20, every $1 When the reserve-deposit ratio = 0.20, every $1 reduction in reserves may reduce the money supply reduction in reserves may reduce the money supply by $5.by $5.

In general, when people make withdrawals, the In general, when people make withdrawals, the money supply contracts by a multiple of the money supply contracts by a multiple of the withdrawal.withdrawal.

Fall in Money SupplyFall in Money Supply= (1/r) x Withdrawal – increase in cash held by public= (1/r) x Withdrawal – increase in cash held by public


Central BanksCentral Banks


4747


Two Main ResponsibilitiesTwo Main Responsibilities– Monetary policyMonetary policy– Oversight and regulation of financial marketsOversight and regulation of financial markets


4848


Their primary mission is to promote low Their primary mission is to promote low inflation, economic growth, and stable inflation, economic growth, and stable financial markets.financial markets.

The Bank of England was founded in 1694.The Bank of England was founded in 1694. The US Federal Reserve System, 1913.The US Federal Reserve System, 1913. Many Latin American countries founded Many Latin American countries founded

central banks in the 1920s.central banks in the 1920s.


5151


Controlling the Money Supply: Open-Market Controlling the Money Supply: Open-Market OperationsOperations– The primary function of Central Banks is The primary function of Central Banks is

monetary policy.monetary policy.– CBs control the money supply by changing the CBs control the money supply by changing the

supply of bank reserves.supply of bank reserves.


5252


Controlling the Money Supply: Open-Market Controlling the Money Supply: Open-Market Operations (OMOs)Operations (OMOs)– Open-market operations are the most important Open-market operations are the most important

method of changing the supply of bank method of changing the supply of bank reserves.reserves.

The “Market” in OMOs is the Market for The “Market” in OMOs is the Market for Government or Central Bank Bonds.Government or Central Bank Bonds.– The CB exchanges bonds for currency.The CB exchanges bonds for currency.


5353

BondBond– A legal promise to repay a debt, usually A legal promise to repay a debt, usually

including both the principal amount and regular including both the principal amount and regular interest payments.interest payments.


Source: www.rainfall.com/ posters/WWI/catalog11.htm


5454

Open Market OperationsOpen Market Operations

Increasing The Money SupplyIncreasing The Money Supply– The Fed purchases US government bonds from The Fed purchases US government bonds from

the public.the public.– The people deposit the funds they get from their The people deposit the funds they get from their

sale of bonds to the Fed.sale of bonds to the Fed.– The increase in deposits increase bank The increase in deposits increase bank

reserves.reserves.


5555


Increasing The Money SupplyIncreasing The Money Supply– The increase in reserves will lead to an The increase in reserves will lead to an

expansion of the money supply as banks make expansion of the money supply as banks make more loans.more loans.

– RecallRecall The change in the money supply is a multiple of the The change in the money supply is a multiple of the

change in reserves.change in reserves.


5656


Reducing The Money SupplyReducing The Money Supply– The CB sells government bonds to the public.The CB sells government bonds to the public.– The CB presents the checks from the sale of The CB presents the checks from the sale of

the bonds to the banks for payment.the bonds to the banks for payment.– The bank’s reserves will fall when they clear the The bank’s reserves will fall when they clear the

checks.checks.– The money supply will fall by a multiple of the The money supply will fall by a multiple of the

decrease in reserves.decrease in reserves.


5757

Open Market PurchaseOpen Market Purchase

Open-Market PurchaseOpen-Market Purchase– The purchase of government bonds from the The purchase of government bonds from the

public by the CB for the purpose of increasing public by the CB for the purpose of increasing the supply of bank reserves and the money the supply of bank reserves and the money supply.supply.


5858

Open Market PurchaseOpen Market Purchase

Fed pays for BOND purchase with a check, which is depositedin a commercial bank

New money becomes a part of the bank’s reserves

Reserves are the basis for additional lending

Additional lending increases the money supply

D → L → D → L → D → L → …


5959

Open Market SaleOpen Market Sale

Open-Market SaleOpen-Market Sale– The sale by the CB of government bonds to the The sale by the CB of government bonds to the

public for the purpose of reducing bank public for the purpose of reducing bank reserves and the money supplyreserves and the money supply


6060

Open Market SaleOpen Market SaleFed receive a check (drawn on a commercial bank deposit) in exchange for the Bond.

Open market sale reduces the supply of bank reserves

Fewer reserves are available to back new loans

Reduction in lending means that fewer dollars will be created.


6161


Suppose the CB wants to increase the Suppose the CB wants to increase the money supply using open-market operations.money supply using open-market operations.

Currency = 1,000 shekels; Reserves = 200Currency = 1,000 shekels; Reserves = 200 Reserve-deposit ratio = 0.2Reserve-deposit ratio = 0.2 Money supply = 1,000 + 200/0.2 = 2,000 shekelsMoney supply = 1,000 + 200/0.2 = 2,000 shekels

What should the CB do?What should the CB do?


6262


An Open Market Purchase increases An Open Market Purchase increases Reserves and the Money SupplyReserves and the Money Supply

Open market purchase = 100Open market purchase = 100 Reserves increase to 300Reserves increase to 300 Money supply = 1,000 + 300/0.2 = 2,500 shekelsMoney supply = 1,000 + 300/0.2 = 2,500 shekels

Money and PricesMoney and Prices


6969


““Inflation is always and everywhere a Inflation is always and everywhere a monetary phenomenon”monetary phenomenon”

-- Milton Friedman-- Milton Friedman

This is true in the This is true in the long runlong run and if inflation and if inflation is is very highvery high..


7070


Price of 1 radio = 4 oranges


7171




7272




7373

Money and PricesMoney and Prices Assume an economy where dollar bills are Assume an economy where dollar bills are

used only once a year (“velocity” = 1); and used only once a year (“velocity” = 1); and where annual real GDP = 10 million houses.where annual real GDP = 10 million houses.

Suppose MSuppose Mss=$10bn. What will P be?=$10bn. What will P be?

MV = PYMV = PY $10bn x 1 = P x 10 million houses$10bn x 1 = P x 10 million houses P = $1 thousand / houseP = $1 thousand / house


7474

Money and PricesMoney and Prices Now suppose MNow suppose Mss=$20bn. What will P be?=$20bn. What will P be? MV = PYMV = PY $20bn x 1 = P x 10 million houses$20bn x 1 = P x 10 million houses P = $2 thousand / houseP = $2 thousand / house If M doubles, P doubles. M/P doesn’t If M doubles, P doubles. M/P doesn’t

change.change. Why doesn’t this happen in the short Why doesn’t this happen in the short

run?run? Because M affects P through the goods, money, and labor Because M affects P through the goods, money, and labor

market, market, over timeover time..


7575


VelocityVelocity– The speed at which money circulates.The speed at which money circulates.

The number of times a dollar bill is used in one year.The number of times a dollar bill is used in one year.

kMoney stoc

GDP Nominal

kMoney stoc

nstransactio of Value Velocity


7676


VelocityVelocity– The speed at which money circulatesThe speed at which money circulates

The number of times a dollar bill is used in one year.The number of times a dollar bill is used in one year.

M

x YP

supply)(money M

GDP) (real x Y level) (price P (V)Velocity


7878


Money and Inflation in the Long RunMoney and Inflation in the Long Run

– Quantity equationQuantity equation

M x V = P x YM x V = P x Y

It’s a definition, so it’s always true.


7979


Money and Inflation in the Long RunMoney and Inflation in the Long Run– Assume Assume V & YV & Y are constant over the time period are constant over the time period

Y x P V x M

PYMV

This is a definition, so it’s always true.

This is a theory, so it may or may not be true.


8080


Money and Inflation in the Long RunMoney and Inflation in the Long Run– Why should we assume Why should we assume V & YV & Y are constant? are constant?– Y is determined by human capital, technology, etc.. Y is determined by human capital, technology, etc..

This theory says economic growth is This theory says economic growth is unrelated to the unrelated to the quantity of moneyquantity of money..

– V is determined by institutions, etc.. V is determined by institutions, etc.. This theoryThis theory says says that the that the needneed for transactions (which use money) is also for transactions (which use money) is also unrelated to the quantity of moneyunrelated to the quantity of money..

– So if we change M, we assume V or Y won’t change. So if we change M, we assume V or Y won’t change. Then assume they are constant.Then assume they are constant.

Y x P V x M


8181


Money and Inflation in the Long RunMoney and Inflation in the Long Run– If the Fed increases If the Fed increases MM by 10%, then prices by 10%, then prices

must increase by 10%.must increase by 10%.– High rates of money growth are associated with High rates of money growth are associated with

high rates of inflation.high rates of inflation.– Too much money is chasing too few goods.Too much money is chasing too few goods.

Y x P V x M


8282

Inflation and Money Growth in Latin Inflation and Money Growth in Latin America, 1995-2001America, 1995-2001


8383


If high rates of money growth lead to If high rates of money growth lead to inflation, why do countries allow their money inflation, why do countries allow their money supplies to rise so quickly?supplies to rise so quickly?– In the case of Ecuador, In the case of Ecuador, because of the need for because of the need for

a lender of last resorta lender of last resort!!– The Central Bank had to print billions of sucres The Central Bank had to print billions of sucres

to try to save the banks from failing … which to try to save the banks from failing … which caused the economy, and the banks, to caused the economy, and the banks, to collapse.collapse.

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Money, Prices, and the Federal Reserve Principles of Macroeconomics Dr. Gabriel X. Martinez Ave...

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