Week 6 - Inflation Flashcards
Define the real economy
The real economy deals with physical goods and services.
Define the financial economy
Relates to the circulation of money and other financial instruments
What is the purpose of financial markets?
Financial markers better allow people to defer current spending to the future. They are as a link between those who have funds and those who need theme (inter-mediation)
What is the Fischer Separation Theorem?
Describes the relationship between present and future consumption.
What is the fist (smallest) line on the Fischer separation graph?
Line A represents the economy without money. Line A only involves bartering (you can consume all the food now or plant some for later)
What is the curve on the Fischer separation graph?
If one introduces money, you can invest in financial assets and move to curve B. This improves the amount you can defer (greater returns)
What does line B represent on the Fischer Separation graph?
Represents full financial inter-mediation (not just cash). This allows people to combine real assets with financial instruments and the trade-off expands.
How is the price of being able to transfer money across time?
Determined by the quantity of loanable funds (by supple and demand model) and results in the interest rate.
What is the result of increasing demand for loan able funds
A technical change that increases the demand for loanable funds (such as new technology) would require a large investment now. This results in increasing the price (interest rate).
What is an example of a supply shock on loanable funds?
A government deficit takes surplus funds out of circulation. This causes an increase in price.
Explain the concept of neutrality of money.
Claims that changes in the money supply have no real effects on the economy and only affect prices since the relative prices are unchanged.
What is the classical dichotomy
Claims that in the long run, the real and nominal economies are separate.
What are the 4 costs of inflation?
1) arbitrary redistribution of wealth (savers are hurt as the value of their money falls due to lags in the deposit rates and a missallocation of real resources due to the lag)
2) tax distortions (e.g. bracket creep)
3) Shoe leather costs (people want to spend sooner and search costs are incurred)
4) Menu costs (adjusting prices has a cost)
What is the real interest rate?
Real interest rate = nominal rate + inflation rate
What happened with the collapse of nationalist China in 1946
Caused hyperinflation as the government printed money to help with the war effort. Larger denominations of currency needed to be made and hyperinflation only stopped when the government was driven out.
