▶ What Is Inflation? | Price Inflation Versus Printing Money Inflation
Lecturer: Dr. Edward Asiedu, UGBS Contact Information ......Inflation Dr. Edward Asiedu Slide 19...
Transcript of Lecturer: Dr. Edward Asiedu, UGBS Contact Information ......Inflation Dr. Edward Asiedu Slide 19...
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College of Education
Department of Distance Education 2017/2018
Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected]
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Session Overview
By the end of this session students should be able to:
• Illustrate the market for reserves and demonstrate how changes in monetary policy can affect the policy rate.
• Assess the relationship between money growth and inflation in the short run and the long run, as implied by the quantity theory of money.
• Identify the circumstances under which budget deficits can lead to inflationary monetary policy.
Dr. Edward Asiedu Slide 2
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Session Outline
The key topic to be covered in the session is the demand
for money:
More specifically:
• How Changes in the Tools of Monetary Policy Affect
the Policy Rate
• Quantity theory of money
• Inflation
Dr. Edward Asiedu Slide 3
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Reading List
• Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets, 7th or 9th edition (Addison Wesley: New York).
• Walsh, Carl E. Monetary theory and policy. MIT press, 2010
Dr Edward Asiedu Slide 4
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HOW CHANGES IN THE TOOLS OF MONETARY POLICY AFFECT THE POLICY RATE
Topic One
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Slide 5
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How Changes in the Tools of Monetary Policy
Affect the Policy Rate
• Effects of open an market operation depends on whether
the supply curve initially intersects the demand curve in its downward sloped section versus its flat section.
• An open market purchase causes the policy rate to fall whereas an open market sale causes the policy to rise (when intersection occurs at the downward sloped section).
• Open market operations have no effect on the policy rate when intersection occurs at the flat section of the demand curve.
Dr. Edward Asiedu
Slide 6
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How Changes in the Tools of Monetary Policy Affect the Policy Rate
• If the intersection of supply and demand occurs on
the vertical section of the supply curve, a change in
the discount rate will have no effect on the policy
rate.
• If the intersection of supply and demand occurs on
the horizontal section of the supply curve, a change
in the discount rate shifts that portion of the supply
curve and the policy rate may either rise or fall
depending on the change in the discount rate
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Slide 7
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How Changes in the Tools of Monetary Policy Affect the Policy Rate
Figure 3 Response to a Change in the Discount Rate
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Slide 8
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How Changes in the Tools of Monetary Policy Affect the Policy Rate
• When the Central Bank raises reserve requirement,
the policy rate rises and when the Central Bank
decreases reserve requirement, the policy rate falls.
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Slide 9
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How Changes in the Tools of Monetary Policy Affect the Policy Rate
Figure 4 Response to a Change in Required Reserves
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Slide 10
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QUANTITY THEORY OF MONEY Topic Two
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Quantity theory of money
Velocity of Money and The Equation of Exchange:
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M = the money supply
P = price level
Y = aggregate output (income)
P ´ Y = aggregate nominal income (nominal GDP)
V = velocity of money (average number of times per year that a dollar is spent)
V =P ´ Y
M
Equation of Exchange
M ´V = P ´ Y
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Quantity theory of money
Velocity of Money and The Equation of Exchange:
• Velocity fairly constant in short run
• Aggregate output at full-employment level
• Changes in money supply affect only the price level
• Movement in the price level results solely from change in the quantity of money
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Slide 13
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Quantity theory of money
Velocity of Money and The Equation of Exchange:
• Demand for money: To interpret Fisher’s quantity theory in terms of the demand for money…
• Divide both sides by V
When the money market is in equilibrium • M = Md
Let • Because k is constant, the level of transactions generated by a fixed
level of PY determines the quantity of Md. • The demand for money is not affected by interest rates.
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Slide 14
PYV
M 1
Vk
1
PYkM d
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Quantity theory of money
Velocity of Money and The Equation of Exchange:
• From the equation of exchange to the quantity theory of
money:
Fisher’s view that velocity is fairly constant in the short
run, so that , transforms the equation of exchange into the
quantity theory of money, which states that nominal
income (spending) is determined solely by movements in
the quantity of money M.
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Slide 15
P Y M V
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Quantity theory of money
Velocity of Money and The Equation of Exchange:
• Because the classical economists (including Fisher)
thought that wages and prices were completely
flexible, they believed that the level of aggregate
output Y produced in the economy during normal
times would remain at the full-employment level .
Dividing both sides by , we can then write the price level as follows:
Dr. Edward Asiedu
Slide 16
Y
M VP
Y
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Quantity theory of money and Inflation
Velocity of Money and The Equation of Exchange:
• Percentage Change in (x ✕ y) = (Percentage Change in x) + (Percentage change in y)
• Using this mathematical fact, we can rewrite the equation of
exchange as follows:
• Subtracting from both sides of the preceding equation, and
recognizing that the inflation rate, is the growth rate of the price level,
• Since we assume velocity is constant, its growth rate is zero, so
the quantity theory of money is also a theory of inflation:
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Slide 17
% % % %M V P Y
% % % %P M V Y
% %M Y
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INFLATION Topic Three
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Inflation
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Figure 1 Relationship Between Inflation and Money Growth
Sources: For panel (a), Milton Friedman and Anna Schwartz, Monetary Trends in the United States and the United Kingdom: Their Relation to Income, Prices, and Interest Rates, 1867–1975; Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed .org/fred2/. For panel (b), International Financial Statistics. International Monetary Fund, http://www.imfstatistics.org/imf/.
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Inflation
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Slide 20
Figure 2 Annual U.S. Inflation and Money Growth Rates, 1965–2015
Sources: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2/.
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Inflation
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Slide 21
Budget Deficits and Inflation
• There are two ways the government can pay for spending: raise revenue or borrow
Raise revenue by levying taxes or go into debt by issuing government bonds
The government can also create money and use it to pay for the goods and services it buys
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Inflation
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Slide 22
Budget Deficits and Inflation
• The government budget constraint thus reveals two important facts:
If the government deficit is financed by an increase in bond holdings by the public, there is no effect on the monetary base and hence on the money supply.
But, if the deficit is not financed by increased bond holdings by the public, the monetary base and the money supply increase.
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Inflation
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Slide 23
Hyperinflation
• Hyperinflations are periods of extremely high inflation of more than 50% per month.
• Many economies—both poor and developed—have experienced hyperinflation over the last century, but the United States has been spared such turmoil.
• One of the most extreme examples of hyperinflation throughout world history occurred recently in Zimbabwe in the 2000s.