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Lecture Principles of economics - Chapter 30: Money growth and inflation

After completing this chapter, students will be able to: See why inflation results from rapid growth in the money supply, learn the meaning of the classical dichotomy and monetary neutrality, see why some countries print so much money that they experience hyperinflation, examine how the nominal interest rate responds to the inflation rate, consider the various costs that inflation imposes on society. | 30 Money Growth and Inflation The Meaning of Money Money is the set of assets in an economy that people regularly use to buy goods and services from other people. THE CLASSICAL THEORY OF INFLATION Inflation is an increase in the overall level of prices. Hyperinflation is an extraordinarily high rate of inflation. THE CLASSICAL THEORY OF INFLATION Inflation: Historical Aspects Over the past 60 years, prices have risen on average about 5 percent per year. Deflation, meaning decreasing average prices, occurred in the U.S. in the nineteenth century. Hyperinflation refers to high rates of inflation such as Germany experienced in the 1920s. THE CLASSICAL THEORY OF INFLATION Inflation: Historical Aspects In the 1970s prices rose by 7 percent per year. During the 1990s, prices rose at an average rate of 2 percent per year. THE CLASSICAL THEORY OF INFLATION The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate. . | 30 Money Growth and Inflation The Meaning of Money Money is the set of assets in an economy that people regularly use to buy goods and services from other people. THE CLASSICAL THEORY OF INFLATION Inflation is an increase in the overall level of prices. Hyperinflation is an extraordinarily high rate of inflation. THE CLASSICAL THEORY OF INFLATION Inflation: Historical Aspects Over the past 60 years, prices have risen on average about 5 percent per year. Deflation, meaning decreasing average prices, occurred in the U.S. in the nineteenth century. Hyperinflation refers to high rates of inflation such as Germany experienced in the 1920s. THE CLASSICAL THEORY OF INFLATION Inflation: Historical Aspects In the 1970s prices rose by 7 percent per year. During the 1990s, prices rose at an average rate of 2 percent per year. THE CLASSICAL THEORY OF INFLATION The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate. Inflation is an economy-wide phenomenon that concerns the value of the economy’s medium of exchange. When the overall price level rises, the value of money falls. Money Supply, Money Demand, and Monetary Equilibrium The money supply is a policy variable that is controlled by the Fed. Through instruments such as open-market operations, the Fed directly controls the quantity of money supplied. Bullet 2: Mankiw has removed the word, “directly” Money Supply, Money Demand, and Monetary Equilibrium Money demand has several determinants, including interest rates and the average level of prices in the economy. Money Supply, Money Demand, and Monetary Equilibrium People hold money because it is the medium of exchange. The amount of money people choose to hold depends on the prices of goods and services. Money Supply, Money Demand, and Monetary Equilibrium In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply. Figure