1

Ch4Money and Inflation

Mankiw: Macro Ch 4Mankiw: Econ Ch24, Ch29, Ch30

2

Outline The classical theory of inflation

causes effects social costs

Classical: assumes prices are flexible

and markets clear Applies to the long run

3

The connection between money and prices

Inflation rate = the percentage increase in the average level of prices.

Price = amount of money required to buy a good.

Prices are defined in terms of money. Value of money =1/price

4

Definition of Money

Barter economy ( 以物易物 ):

to require Double Coincidence of Wants

( 慾望的雙重巧合 )

MoneyMoney is the stock of assets that can be readily u is the stock of assets that can be readily used to make transactions.sed to make transactions.

5

Three Functions of Money

1. Store of Value 價值儲存a transfers purchasing power from the present to the

future

eg, money, bond, stock, house

2. Unit of Account 計價單位the common unit by which everyone measures prices and values

3. Medium of Exchange 交易媒介we use it to buy stuff eg, money, check

6

The Functions of Money Liquidity 流動性：

the ease with which an asset can be converted into the economy’s medium of exchange.

The most liquid asset is currency and check.

Other asset is less liquid because it takes time to convert itself to a medium of exchange.

7

The Kinds of Money Commodity money 商品貨幣 takes the form of a commodity

with intrinsic value. eg, gold, silver, cigarettes, wine.

Fiat money 法幣 is used as money

because of government decree. It does not have intrinsic value. eg, coins, currency, check deposits.

8

Money supply and monetary policy: definitions

Money supply:

the quantity of money available in the economy.

Monetary policy:

the control over the money supply.

9

The Federal Reserve System:U.S. Central Bank Monetary policy is conducted by a country’s central bank.

In the U.S., the central bank is

The Federal Reserve ：美國聯邦儲備理事會serves as the nation’s central bank. It is designed to oversee the banking system. It regulates the quantity of money in the economy.

The chairman ： Ben Bernake 貝南克 (2006/2- ) 1987-2005 ： Alan Greenspan 格林斯潘

10

Taiwan: Central Bank (CB) 中央銀行總裁：彭淮南（ 1998 年 - ）一、理事會：理事 11 至 15 人，主要職掌有關貨幣、信用及外匯政

策事項之審議。中央銀行總裁、財政部部長、經濟部部長為當然理事；並應有實際經營農、工、商業及銀行業者至少各一人擔任理事。總裁並為理事會主席。除當然理事外，理事任期為五年，期滿得續派連任。

二、監事會：監事會置監事 5 至 7 人，主要職掌資產、負債之檢查。行政院主計長為當然監事。監事任期為三年，期滿得續派連任。

參考：央行網站 http://www.cbc.gov.tw/ 認識中央銀行，金融變數說明，重要金融指標。

11

Money supply measures Money supply refers to the quantity of money ava

ilable in the economy. Money = Currency + Demand deposit M =C+D --- Money Supply (Ms) 1. Currency (C) ：通貨淨額 paper bills and coins in the hands of the public. 全體貨幣機構與郵政儲匯處以外各部門持有通貨 = 央行通貨發行額－全體貨幣機構郵政儲匯處庫存現金

2. Demand deposits (D) ：支票存款 balances in bank accounts that depositors can access

on demand by writing a check.

12

Money Aggregate 貨幣總計數 M1A = 通貨淨額 + 支票存款及活期存款

M1B = M1A ＋活期儲蓄存款 = 通貨淨額＋存款貨幣( 存款貨幣 = 支票及活期存款 + 活期儲蓄存款 )

M2 = M1B ＋準貨幣

13

Quasi-money 準貨幣 Quasi- Money 準貨幣：

定期存款（一般定存、可轉讓定期存單）、定期儲蓄存款、

外匯存款（外匯活期存款、外匯定期存款）、郵政儲金總數 ( 劃撥儲金、存簿儲金、定期儲金 )

自 1994 年 1 月起尚包括附買回交易餘額、與外國人持有新台幣存款 ( 含活期、定期 ) ；

自 2004 年 10 月起包括貨幣市場共同基金。

14

Figure Money in Taiwan Economy （ 2007 ）

Copyright©2003 Southwestern/Thomson Learning

億元

• Currency($10,092)

• Demand deposits• Traveler’s checks• Other checkable deposits

• Everything in M1A($31,566)

• Savings deposits• Small time deposits• Money market mutual funds• A few minor categories

M1A+SD=M1B ( $82,200)

0

M1A$31,566

M2$260,394

15

Taiwan data: money supply

Fig 29.1 M1B, M2 1961-2007貨幣總計數（名目 ）：

0

50,000

100,000

150,000

200,000

250,000

300,000

年度

億元 M1B

M2

16

Taiwan data: Real money supply

Fig 30.1 1961-2007實質貨幣

0

50000

100000

150000

200000

250000

300000

年度

億元 real M1B

real M2

17

M=C+D:CB’s 3 Tools of Monetary Control

1. Open-market operations 公開市場操作(1) To increase the money supply, the CB buys government

bonds from the public. 收回債券、釋出貨幣(2) To decrease the money supply, the CB sells government

bonds to the public. 釋出債券、收回貨幣2. Changing reserve requirement 改變法定準備率(regulations on the minimum amount of reserves that banks m

ust hold against deposits.)

3. Changing the discount rate 改變重貼現率(the interest rate the Fed charges banks for loans.)

18

U.S. inflation and its trend, 1960-2006

slide 18

0%

3%

6%

9%

12%

15%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

long-run trend

% change in CPI from 12 months earlier

19

Theory of Money1. Quantity theory of money2. LR ： Ch 4, M-P

The Classical Theory of Inflation3. SR ： Ch10, M-r (LM curve) Keynesian interest-rate determination

Ch 4: 1&2 relate M and P2 & 3: The monetary equilibrium ：

Money supply + Money demand

20

Classical theory of Inflation:

LR Monetary Equilibrium Monetary Equilibrium 貨幣的均衡：

Money supply + Money demand

Money supply ： a policy variable that is controlled by the CB.

Money supply is fixed ： vertical.

21

Money Demand Money demand has several determinants, including rea

l income (Y),

nominal interest rates (R), and

the average level of prices (P) in the economy.

Md : nominal money demand （ L: liquidity ） L= Md /P = real money demand

.

* ( , )dM P L Y R

22

Money Demand

L: liquidity

(1) People hold money because it is the medium of exchange. As Y↑, L↑.

(2) Money, as an asset, has lower return compared with bonds. As R↑, L↓.

(3) As Y and R fixed (L fixed), Md depends on P.

As P↑, Md ↑ proportionally. Md is positively sloped.

* ( , )dM P L Y R

23

LR Monetary Equilibrium

In the long run,

the overall level of prices adjusts to the level at which the demand for money equals the supply.

Ms=Md (Md=P*L) as P=P*

Or Ms /P =L as P=P* M/P = real money balances

= the purchasing power of the money supply

24

Figure Money Supply, Money Demand, and the Equilibrium Price Level

Copyright © 2004 South-Western

Money demand

Quantity of Money

P

Quantity fixedby the CB

Money supply

0

4

2

1

3

Equilibriumprice level

A

25

Comparative Static 1: M△ s

The Effects of a Monetary Injection

Helicopter Money 直昇機貨幣 （ Money Rain ）The CB increases money supply. Ms curve shifts to the right. Price level rises, with same proportion as Ms.

eg, If the money supply doubles (Ms2=2Ms

1) ，and the price level doubles, (P*=24)

26

Fig The Effects of Money Injection

Copyright © 2004 South-Western

Md

Quantity of Money

Price

Ms1

Ms

0

4

2

1

3

A

Ms2

MS’

B

27

The increase in Money supply

Reasoning: An increase in Money supply, given the same output At the original price, there exists ESM:

Too much money is chasing the same amounts of goods. The price level rises.When reaching new equilibrium, P

↑ with the same proportion as Ms.

太多的貨幣追逐太少的貨物，造成物價上漲。 物價上漲幅度與貨幣增加幅度相同。 △Ms △P: LR phenomenon

28

The increase in Money supplyReasoning: (2) When the overall price level rises, the value of money falls. The value of money =1/Peg, P doubles, (P*=24) and the value of money becomes one h

alf of the initial value. (1/21/4) To purchase the same amount of goods,

the households have to hold more money: to double their money demand. (movement along Md curve)

Inflation is an economy-wide phenomenon that concerns value of the economy’s medium of exchange.

29

Real and Nominal Interest Rates

Interest represents a payment in the future for a transfer of money in the past.

Nominal interest rate （ R ，名目利率） :

the interest rate usually reported. It is the interest rate that a bank pays.

Real interest rate （ r ，實質利率） :

nominal interest rate corrected for the effects of inflation.

30

Real and Nominal Interest Rates You lend out $100 for one year. P=$1/candy Nominal interest rate was 10%. During the year inflation was 6%. Present $100/$1= 100 units of candies $100*(1+10%)/[$1*(1+6%)]=103.7 units of candies Real return= 3.7 units, real rate of return= 3.7% Real interest rate （ real rate of return ）近似 = Nominal interest rate – Inflation rate= 10% - 6% = 4% ( r=R-π)

31

R , r, and expectation r =R-π

So r <0 if R<π r >R if π<0

契約訂定名目利率 R= re + πe (e: expected ，預期的 )πe :expected inflation rate ， re : ex ante real interest rate

實現的（ realized ）或實際的 (actual) 或 ex post （事後的）r =R-π ＝ re + πe -π ，So r < re if πe <π r = re if πe=π r > re if πe >π

32

The Fisher Effect ( 費雪方程式 )

r = R-π R= re+πe (e: expected)

Fisher effect:

(1) a one-to-one adjustment of the nominal interest rate to the inflation rate.

ie, when πrises, R rises by the same amount.

(2) r stays the same. (Ch 3: S=I determines r)

33

Inflation and nominal interest rates in the U.S., 1955-2006

percent per year

-5

0

5

10

15

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

inflation rate

nominal interest rate

34

Inflation and nominal interest rates across countries

1

10

100

0.1 1 10 100 1000

Inflation Rate (percent, logarithmic scale)

Nominal Interest Rate

(percent, logarithmic scale)

1

10

100

0.1 1 10 100 1000

Inflation Rate (percent, logarithmic scale)

Nominal Interest Rate

(percent, logarithmic scale)

Switzerland

Germany

Brazil

Romania

Zimbabwe

Bulgaria

U.S.

Israel

35

Taiwan data ： R, π and r　 Inflation rate (CPI) Nominal R Real r

1961-2007 4.35 5.03 0.68

1961-1970 2.92 4.58 1.66

1971-1980 11.07 6.95 -4.12

1981-1990 3.15 5.95 2.80

1991-2000 2.59 5.06 2.47

2001-2007 0.83 1.51 0.68

　 　 　 　1974 47.50 8.50 -39.00

1980 19.01 9.75 -9.26

1981 16.32 10.25 -6.07

2001-2007 (-) 　 零利率年代

36

Taiwan: R and πFIGURE 30.5 The Nominal Interest Rate and the Inflation Rate

-10

0

10

20

30

40

50

1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006

Year

Inte

rest Rate

and Inflation R

ate

in P

erc

ent

Nominal Interest Rate Inflation Rate

37

Taiwan: R and rFIGURE 24.3 Nominal and Real Interest Rate

-50

-40

-30

-20

-10

0

10

20

1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006

Year

Real In

tere

st Rate

in P

erc

ent

38

R and r Real interest rate (r) is the relative price for intertemp

oral choice:

consumption now or later

(saving and investment) Nominal interest rate (R) is the relative price for mon

ey demand:

the difference between the rates return, nominal or real, for money holding or bond holding is R.

39

Nominal variables vs. Real variables Nominal variables 名目變數

are variables measured in monetary units.eg, Nominal GDP=PY, Nominal wage W=Pw,

Nominal interest rate R= r+π.

Real variables 實質變數are variables measured in physical units.

eg, Real GDP=Y, Real wage w=W/P, Real interest rate r.

40

A broader view of macro model

Ch3 macro model: real side of the economy

3 markets and 2 prices to assure general equilibrium:

(1) LF market: S(r) = I(r) r*

(2) Labor market: W/P =MPL (W/P)*, L*

(3) Goods market:

本期給定 K, 由 r* = MPK –δ 決定 I 與下期 K

Y(LR) is determined by the supply side. Y=AF(K, L*)

而 r* C, S, I:即決定 Yd 成分

41

The Classical Dichotomy and Monetary Neutrality Ch4: 4 markets and 3 prices

Here, add one more market (money market)

and this market determine price (P) independently.

Classical dichotomy 古典二分法：different forces influence real and nominal variables.

Changes in the money supply only affect P (and π)

and only affect nominal variables (PY, W, R).

But do not affect the real side of the economy( Y, r, (W/P), C, I, K, L).

The irrelevance of monetary changes for real variables: monetary neutrality. ( 貨幣中立性 )

42

Comparative Static 2: △πe

In LR, people don’t consistently over- or under-forecast inflation, so e = on average.

In SR, e may change when people get new information.

eg: CB announces it will increase M next year. People will expect next year’s P to be higher, so e rises.

This affects P now, even though M hasn’t changed yet….

43

How P responds to e

( , )eML r Y

P

For given values of r, Y, and M ,

mequilibriumarket money restore to

market goods toflowsmoney ofSupply Excess

)effectFisher (

P

L

R

e

44

The Quantity Theory of Money貨幣數量學說 Fisher (1911) A simple theory linking the inflation rate to the

growth rate of the money supply.M V = P Y

Where:P = the price levelY = the quantity of outputM = the quantity of money

V = velocity of money

45

Velocity of money

V = (P Y)/M

Velocity of money ( 貨幣流通速度 ) ：defn: the number of times the average dollar bill ch

anges hands in a given time period

--- the rate at which money circulates.

LR ： V is relatively stable over time.

46

Taiwan data: GDP,M and V

Fig 30.3 1961-2007 (1961=100)貨幣數量、產出、與貨幣流通速度

0

20000

40000

60000

80000

100000

120000

140000

160000

年度

億元

M2

GDP名目

Velocity of money

47

Quantity equation :Inflation and money growth rate

M V = P Y The quantity equation shows that M ↑

must be reflected in one of 3 other variables:P↑ or Y↑ or V↓

LR V is relatively stable over time. LR Y is determined by the supply side.

(If factors of production are fixed, Y is fixed. )1. P=MV/Y: M↑ only induces P↑ proportionally.The same result as the analysis of monetary equilibrium.2. Money does not affect output: Money is neutral.

實質產出不受影響 : 貨幣中立性

48

International data on inflation and money growth

0.1

1

10

100

1 10 100Money Supply Growth (percent, logarithmic scale)

Inflation rate (percent,

logarithmic scale)

0.1

1

10

100

1 10 100Money Supply Growth (percent, logarithmic scale)

Inflation rate (percent,

logarithmic scale)

Singapore

U.S.

Switzerland

Argentina

Indonesia

Turkey

BelarusEcuador

49

U.S. inflation and money growth, 1960-2006

slide 49

0%

3%

6%

9%

12%

15%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

M2 growth rate

inflation rate

Over the long run, the inflation and money growth rates move together,

as the quantity theory predicts.

Over the long run, the inflation and money growth rates move together,

as the quantity theory predicts.

50

Taiwan data: Inflation rate and money growthTaiwan 　 Inflation rate

(CPI)M1B growth rate

M2 growth rate

1961-2007 3.97 17.04 17.56

1961-1970 2.92 18.69 20.78

1971-1980 11.07 28.03 26.06

1981-1990 3.15 18.12 20.84

1991-2000 2.59 8.99 11.88

2001-2007 -0.49 9.17 4.71

1974 π=47.50% 　 　1980 π=19.01% 　 　1981 π=16.32% 　 　2001-2003 π<0 　 　

51

Taiwan: Inflation rate and money growth

Fig 30.4 CPI :1961-2007貨幣成長率與通貨膨脹（ ）

-10

0

10

20

30

40

50

年

%年

增率

M2

inflation rate (CPI)

52

Quantity equation :Inflation and money growth rate

M

M

P

P

Y

YIf

Y

Y

M

M

P

P

V

VLR

Y

Y

P

P

V

V

M

M

PYMV

,0 also )2(

,0:)1(

The primary cause of inflation is the growth in the quantity of money:

the data is consistent with this implication.

53

Quantity equation :Inflation and money growth rate

Y

Y

M

MIf

Y

YNormally

sets CB then ,0set tois goalgovt

,0 )3(

Monetarism 貨幣學派 (Friedman) :Money serves as medium of exchange. And Monetary policy is made by rule.

54

Money demand and the quantity equation

In the quantity theory of money, the demand for real money balances depends only on real income Y.

A simple money demand function:

M d/P = k Yk = how much money people wish to hold for each dollar of income. (k is exogenous)

55

Money demand and the quantity equation

money demand: M d/P = k Y quantity equation: M V = P Y The connection: k = 1/V

When people hold lots of money relative to their incomes (k is high), money changes hands infrequently (V is low).

56

The Social Costs of Inflation Common misperception:

inflation reduces real wages

and reduce purchasing power. True only in the short run,

when nominal wages are fixed by contracts. Ch 3: In LR, real wage is determined by

labor supply and the marginal product of labor,

not the price level or inflation rate.

57

Average hourly earnings and the CPI, 1964-2006

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

1964 1970 1976 1982 1988 1994 2000 2006

ho

url

y w

age

0

50

100

150

200

250

CP

I (1

982-

84 =

100

)

CPI (right scale)wage in current dollarswage in 2006 dollars

58

The Social Costs of Inflation The classical view of inflation:

A change in the price level is merely a change in the units of measurement.

(1) If inflation raises nominal incomes proportionally, the real income stays the same. --- neutrality

(2) R= re +πe ， r = R-π= re +(πe –π)

If πe =π ， r = re

t o

t o

W W

P P=

59

The Social Costs of Inflation Inflation does not in itself reduce people’s

real purchasing power. Costs of expected Inflation:

Shoeleather costs

Menu costs

Relative price distortions

Unfair tax treatment and tax distortion

Confusion and inconvenience Costs of Unexpected Inflation:

Arbitrary Redistribution of Wealth

60

1. Shoeleather Costs (鞋帶成本 ) In LR, inflation does not affect real income or real spending. But π↑ R↑L↓ So, same monthly spending but lower average money holdings

means more frequent trips to the bank to withdraw smaller amounts of cash.

Shoeleather costs : It take s time and inconvenience for people to make the extra trips to the bank.

take time away from productive activities.

61

2. Menu Costs （菜單成本） Menu costs :

the costs of adjusting prices. During inflationary times, it is necessary to update

price lists and other posted prices.

a resource-consuming process that takes away from other productive activities.

62

3. Relative-Price distortions Inflation distorts relative prices. Consumer decisions are distorted,

and markets are less able to allocate resources to their best use.

Microeconomic inefficiencies due to misallocation of Resources

63

4. Unfair tax treatment and Tax Distortion

Inflation exaggerates the size of capital gains and increases the tax burden on this type of income.

(1) The income tax treats the nominal interest earned on savings as income,

even though part of the nominal interest rate merely compensates for inflation.

(2) The after-tax real interest rate falls

making saving less attractive.

64

Table How Inflation Raises the Tax Burden on Saving

Copyright©2004 South-Western

65

5. Confusion and Inconvenience When the CB increases the money supply and creates

inflation, it causes dollars at different times to have different real values.

It is more difficult to compare real revenues, costs, and profits over time:

It erodes the real value of the unit of account.

66

6. A Cost of Unexpected Inflation: Arbitrary Redistribution of Wealth

(1) Principal ： Debt/P = real debt↓ as P↑

(2) Returns ：R= re +πe ， r = R-π= re +(πe –π)

If πe <π ， r < re

Lower rate of return for lenders,

and lower cost of borrowing for borrowers.

Unexpected inflation redistributes wealth among the population from the lenders to the borrowers.

67

One benefit of inflation Nominal wages are rarely reduced, even when the

equilibrium real wage falls. This hinders labor market clearing.

Inflation allows the real wages to reach equilibrium levels without nominal wage cuts.

Therefore, moderate inflation improves the functioning of labor markets.

68

CASE STUDY: Money and Prices during Four Hyperinflations

Hyperinflation is inflation that exceeds 50 percent per month. Hyperinflation occurs in some countries because the

government prints too much money to pay for its spending. If it prints money rapidly enough, the result is hyperinflation.

Money ceases to function as a store of value, and may not serve its other functions (unit of account, medium of exchange).

People may conduct transactions with barter or a stable foreign currency.

In theory, the solution to hyperinflation is simple: stop printing money.

69

The Inflation Tax ( 通膨稅 ) Gov’t BC :

Seigniorage: the “revenue” raised from printing money.

When gov’t prints money, the price level rises, and the dollars become less valuable.

Inflation tax: like a tax on everyone who holds money The inflation ends when the government institutes

fiscal reforms such as cuts in government spending.

sgB M

G= T + + P P

70

惡性通貨膨脹很多國家曾發生過嚴重的通貨膨脹，受害慘重。尤其是在近代兩次世界大戰之後，許多國家因為生產遭到嚴重破壞，以及龐大的軍費支出，造成財政鉅額赤字，迫使政府大量印發鈔票，而陷入惡性通貨膨脹，經濟體制幾乎瓦解。 ( 央行 )

71

惡性通貨膨脹：台灣四萬舊台幣＝一元新台幣( 資料來源：央行 ) 台灣在光復之初曾遭遇惡性通貨膨脹。民國 34-3

8 年之間，台灣的物價幾乎是一日數變，每年的物價漲幅都在 500％至 1200％之間。

民國 38 年 6 月 15日，台灣實施幣制改革，每四萬舊台幣兌換新台幣一元。

72

惡性通貨膨脹：美國 US: over the past 60 years, prices have risen

on average about 5 % per year. Deflation (π<0 ，通貨緊縮 ) ：

decreasing average prices, occurred in the U.S. in the nineteenth century. （ Taiwan: 2001-2003 ）

In the 1970s prices rose by 7 % per year. During the 1990s, prices rose at an average rate of

2 % per year.

73

惡性通貨膨脹：德國德國通貨膨脹經驗慘痛： 第一次世界大戰後的 1923 年，德國陷入惡性通貨膨脹，物價較戰前上漲一萬四千億倍，一份報紙售價二千億馬克。

第二次世界大戰結束後，德國再度出現惡性通貨膨脹， 1947 年間，德國大半交易被迫改用以物易物的方式進行。

世界上最大的通貨膨脹是二次戰後的匈牙利，自 1945/7-1946/8 的 13 個月間，物價上升 3*1025 。

74

A few examples of hyperinflation

money growth

(%)

inflation (%)

Israel, 1983-85 295 275

Poland, 1989-90 344 400

Brazil, 1987-94 1350 1323

Argentina, 1988-90 1264 1912

Peru, 1988-90 2974 3849

Nicaragua, 1987-91 4991 5261

Bolivia, 1984-85 4208 6515

75

中央銀行的責任，物價穩定最優先

( 資料來源：央行 ) 目前國際間普遍認為：

中央銀行應以物價穩定為首要政策目標；只有物價穩定，才能促進經濟均衡且持久的成長。同時，為了有效地穩定物價，應該要賦予中央銀行獨立性，使中央銀行能以超然的地位行使職責。

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Chapter SummaryChapter Summary Functions of money Money supply Money demand Theory of monetary equilibrium Quantity theory of money and Velocity of money Nominal and real interest rate

expected inflation rate Fisher effect

CHAPTER 4 Money and Inflation slide 76

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Chapter SummaryChapter Summary Nominal and real variables Classical dichotomy Monetary neutrality Social costs of inflation Hyperinflation Seigniorage and inflation tax

CHAPTER 4 Money and Inflation slide 77