Money, Prices, and Inflation in the Global Economy

1. MACROECONOMICSAND THE GLOBAL BUSINESS ENVIRONMENT 2nd edition Money and Prices

2. Key Concepts • Inflation • Hyperinflation • Inflation Tax and Seignorage • Monetarism • Money Neutrality • Quantity Theory

3. Inflation • The rate of change in the price level P(1) – P(0) Rate of Inflation = P(0)

4. UK Prices, 1661 - 1991

5. UK Inflation, 1661 - 1999

6. U.S. Prices, 1800 - 2000

7. G7 Inflation, 1975 - 2000

8. Measuring Inflation • Consumer Price Index (CPI) • Producers’ Price Index (PPI) • GDP Deflator • Ratio of Nominal GDP to Real GDP • Mis-measurement issues • Substitution • Quality

9. 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?

10. 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

11. 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

12. 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) Money

13. 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

14. Money

17. 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

18. Monetary Aggregates, (Billions $) M3 Source: Board of Governors On-line Statistics

19. $71 $100 $90 Money Multiplier Vault Accumulation $10 $19 $26.10 … $100 … $100 $190 $261 … $1000 Total Money Base Currency M1

20. Money Multiplier

21. 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

22. 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

23. Hyperinflation • High and persistent rate of inflation • Relationship to fiscal policy Finance government. spending via inflation tax Rising Inflation Declining value of Money People decrease money holdings by buying goods

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

26. 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

27. Quantity Theory MV = PY Velocity: the circulation rate of money Inflation is always and everywhere monetary phenomenon. Milton Friedman

28. %M + %V = %P + %Y • Assume V = constant, so %V = 0 • %M = %P + %Y • %Y determined by investment, technology, etc. • %M is proportional to %P Growth in Money Supply Seignorage Inflation

29. US Inflation and Money Growth

30. UK Inflation and Money Growth

31. Cross-country Inflation and Money Growth, Long Run

32. Cross-country Inflation and Money Growth, Short Run

33. Summary • Inflation • Measures • Costs • Deflation • Money • Definitions • Multiplier • Seignorage and Inflation Tax • Hyperinflation