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INFLATION
TERMINOLOGY
Secured De; Debts secured by collateral (Mortgage, if not paid
property can be sized) Cash rate: Interest rate central bank
charges on overnight loans to commercial banks Inflation targeting
; Setting a target inflation and steering towards that target
Reserve requirement; Minimum amount of funds banks must retain when
lending Inflation ; Sustained increase of price of general goods
and services
THREE FUNCTIONS OF MONEY
Medium of exchange Unit of account Store of value
KINDS OF MONEY
Commodity moneyGold, silver Fiat moneyCoins , currency
TWO FUNCTIONS OF RESERVE BANK
Administration of monitory policy Maintaining financial
stability
INTRISIC VALUE
Commodity that has a value outside the use as money (Eg,
gold)
MONEY MULTIPLIER
Amount of money that banking system generates with each dollar
of reserves
Money multiplier (M) = 1/R
R = Reserve requirement
^ if reserve requirement is 20% money multiplier is 0.5
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If inflation forecast is above the target
Tighten monetary policy Sell government securitiesIf inflation
target is below the target
Buy government securities Expand monetary policy
Problems faced by RBS in controlling the money supply
It does not control the deposits held by house holds Does not
control the amounts of money lent by banksMONETORY NEUTRALITY
That face that change in money supply not effecting the real
variables like aggregate demand
INFLATION TAX
Government raising revenue by printing money.
MENU COST
Costs associate with changing the price tags and catalogues due
to high inflation.
FISHER EQUATION
Nominal interest rate =Real interest rate + Inflation rate
INFLATION
TERMINOLOGY
Inflation; Increase in the price of goods and services Hyper
inflation; Very level of inflation Quantity theory of money;
Relationship between value of money and the price of goods and
services Shoeleather costs; Cost of time and effort trying to
counter-act inflation Menu costs; Cost of adjusting prices (cost on
changing price signs)
Velocity and quantity equation
V= (P x Y)/M
V= velocity
P= the price level
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Y = Quantity of output
M = Quantity of money
By rewriting this
M x V = P x Y
Quantity of money = nominal value of output
Result of increase in the quantity of money
the price level must rise the quantity of output must rise or
the velocity of money must fall.
Nominal interest rate = Real interest rate + Inflation rate
ECONOMISTS HAVE IDENTIFIED SIX COSTS O F INFLATION:
shoeleather costs menu costs increased variability of relative
prices unintended tax liability changes confusion and inconvenience
arbitrary redistributions of wealth
