Money and Inflation

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Money and Inflation
ECO 105 Lecture 4.1 10 November 2008
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Inflation in the 20th Century

• A basket of goods that cost 100 in 1954 would
  cost
• Prices have been rising since
• It wasnt always so.
• The late 19th century saw
• Now we almost always
• What has changed?

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What is inflation?

• A sustained increase in the general price level

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Causes of Inflation

• Observation Money and price levels are

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Why the Correlation?

• Quantity theory of money Changes in the money
  supply
• Clearly evident in

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Ernest Hemingway -

• At the Hotel in Triberg the proprietor had a
  fine season. It was very pleasant and we were
  all great friends. The next year came the
  inflation and the money he had made the year
  before was not enough to open the hotel and he
  hanged himself.
• From The Snows of Kilomanjaro

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Monetary Neutrality

• The proposition that, in the long run, an
  increase in the money supply increases only
• Two important questions
• How long is
• By what process are increases in the money supply
  translated into
• Well tackle the second question first.

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What Determines Real Production?

• Real production refers to the actual goods and
  services produced, rather than to their
• Production depends on
• Y A.F (L, K, H)
• Monetary institutions affect A, but the quantity
  of money
• Thus, money is

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Equation of Exchange

• M x V P x Y
• M is a measure of the
• V is velocity, the average no. of times a unit of
  money
• P is a price index e.g.,
• Y is

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In the long run . . .

• The path of Y is determined by
• V has been relatively
• Treating Y and V as independent of M, we can see
  that
• M x V0

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Costs of Inflation

• Check the web site for a reading on this topic.
• We might entertain the hypothesis that, when
  everybody complains of being worse off in the
  face of reportedly unchanged real G.N.P., they
  may be right. -- Axel Leijonhufvud

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Inflation distorts the price system.

• Its like
• It leads to
• It leads to

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Transaction costs increase.

• Shoeleather costs - engaging in more
• Menu costs - changing prices

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Income and wealth are redistributed arbitrarily.

• Asset holders lose,
• Taxpayers are
• Government services
• Productivity may suffer whats a merit raise
  really worth
• Everyone has the feeling that the process is

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Calls for government involvement increase.

• Do something!
• Rejecting equality of opportunity (the rule of
  law) in favor of
• Private contracts give way to
• Regulation increases,