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Ch 28 Money Growth and Inflation

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This chapter delves into the relationship between money supply, inflation, and growth, tracing historical contexts and classical economic theories. It discusses the implications of price levels on the value of money, examining measures such as the Consumer Price Index (CPI) and the GDP deflator. The dynamics of money demand and supply are explored alongside concepts like hyperinflation, monetary injections, and the classical dichotomy, distinguishing between nominal and real values. Ultimately, it highlights the short-term effects of monetary changes on economic variables.

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Ch 28 Money Growth and Inflation

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  1. Ch 28 Money Growth and Inflation I. Historic Look (p628)…inflation vs deflation • hyperinflation

  2. II. Classical Theory of Inflation • P measured by CPI or GDP delator • P measures number of dollars needed to buy basket of goods • The Q of goods you can buy with one dollar = 1/P • So….1/P is the value of money measured in terms of goods and services it buys • So….as P rises,,,,,the value of money falls

  3. III. Value of Money (Supply and Demand) • Money Supply (Fed and banking system); MS is vertical because _____________ • Money Demand :MD is downward sloping because __many___determinants: use of credit cards, interest rates, etc. • --most impt. = price level • the higher P = lower value of money = more money demanded to buy goods. • --the higher P = people hold more money.

  4. Price Level Value = 1/P If P< Pe? 1 1/2 2 If P > Pe? 4

  5. Monetary Injection…immediate impact? : Surplus = ….. Spend or save (= more spending) = …increase AD…..but…? Ability to produce has not changed….so….. Price Level Value = 1/P 1 Creates rise in PL and increase in QD b/c now need more for every transaction 1/2 2 4

  6. Q Theory of Money : • Q of M available determines • the PL • Growth rate of Q of M determines • Inflation Rate

  7. Classical Dichotomy and Monetary Neutrality • How do monetary changes affect other variables (production, employment, wages) • David Hume • classical dichotomy separates “real” and “nominal” variables

  8. Applications • Price of corn = $2/bushel …. = nominal • But the “relative” price: bushel of corn = two bushels of wheat ….. = real • Dollar prices are nominal ; relative prices are real • Ex: real wage = real variable

  9. Analogy • If MS doubles, all P double and the value of a dollar falls by ½ • If change yard from 36 to 18 inches: all measured distances (nominal) would double, but the actual distances (real) would not change

  10. Long run vs. Short run • Monetary changes do effect short run • But in long run – only negligible affects on real variables

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