EC4004 Lecture 10Inflation, Money Growth,
Interest Rates
Stephen Kinsella | www.stephenkinsella.net
Last Time:Data
Inflation & Interest
Inflation in the Equilibrium Business-
Cycle Model
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Inflation in the Equilibrium Business-Cycle Model
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Inflation in the Equilibrium Business-Cycle Model
Intertemporal-Substitution Effects
The expected real interest rate, ret , has
intertemporal-substitution effects on consumption and labor supply.
Therefore, for given it, a change in πt will have these intertemporal-substitution effects.
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Inflation in the Equilibrium Business-Cycle Model
Bonds and Capital
@ ∆πt =0,
i = (R/P)·κ − δ(κ)
rate of return on bonds =
rate of return from owning capital
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Inflation in the Equilibrium Business-Cycle Model
Replace the nominal interest rate on bonds, i, by the real rate, r,
r = ( R/ P) · κ − δ(κ)
real rate of return on bonds =
real rate of return from owning capital.
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Inflation in the Equilibrium Business-Cycle Model
Interest Rates and the Demand for Money
It is the real interest rate, r, that has intertemporal-substitution effects on consumption and labor supply. However, it is the nominal interest, i, that influences the real demand for money, Md/P.
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Inflation in the Equilibrium Business-Cycle Model
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Inflation in the Equilibrium Business-Cycle Model
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Money Growth, Inflation, and the Nominal Interest Rate
∆Mt =Mt+1−Mt
µt = ∆Mt/Mt
Mt+1 = (1+µt)·Mt
πt = ∆ Pt/ Pt
πt = (Pt+1−Pt)/Pt
Pt+1 = (1+πt)·Pt
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Inflation in the Equilibrium Business-Cycle Model
The level of real money demanded, L(Y, i), equals the unchanging level of real money balances, Mt/Pt .
Determination of price level:
P1 = M1 / L( Y, i)
πt, is the constant π = µ.
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Inflation in the Equilibrium Business-Cycle Model
Government Revenue from Printing Money
Nominal revenue from printing money
= Mt+1−Mt = ∆Mt
Real revenue from printing money
= ∆Mt/ Pt+1
Real money growth rate
µt = ∆ Mt/ Mt
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Inflation in the Equilibrium Business-Cycle Model
Government Revenue from Printing Money
Real revenue from printing money
= µt·(Mt/Pt+1)
Real revenue from printing money
≈ µt·( Mt/ P)
= (money growth rate)·(level of real money
balances)
Next Time
Recap.
Read Barro chapters 1-12, come with questions.