Output, Inflation, and the Quantity Theory of Money. Ref: Chap 20 p454-57, & Chap 21 p481-89

Transcription

1 Oupu, Inflaion, and he Quaniy Theory of Money Ref: Chap 20 p454-57, & Chap 21 p481-89

2 Aggregae Oupu (Income) Aggregae Oupu is measured by GDP, Gross Domesic Produc: The marke value of final goods and services produced in a counry during a year. Aggregae Income is measured by GNI, Gross Naional Income: Toal income of facors of producion (land, capial, labour) during a year. I4-2

3 Aggregae Oupu (Income) Con d GDP versus GNI GDP and GNI are ofen very abou he same magniude. Quesions: Why do hey differ in magniude, and when are hey he same? When is i beer o use GDP? I4-3

4 Aggregae Oupu (Income) Con d Real versus Nominal GDP: - Disinguish changes in prices from changes in quaniies. - Real GDP uses base-year prices and isolaes change in quaniies. GDP Deflaor=100 x Nominal GDP Real GDP I4-3

5 Aggregae Oupu (Income) Con d Y denoes Aggregae Real Oupu Noe: indicaes oupu over a ime period. e.g. year = 2012 so Y 2012 is aggregae real income from he beginning o he end of he year Noe: Oupu is a flow variable (in unis per period of ime) I4-4

6 P denoes he Aggregae Price Level = The Price Level Aggregae Nominal Oupu Aggregae Real Oupu ( ) Y A price is a level variable, so subscrip corresponds o a specific ime in period, usually he end of period. P, like he CPI, is in dollars per uni quaniy of goods and services. I4-5

7 I4-6 π denoes he (ne) π Inflaion P P P P P P P 1 = Inflaion Rae where " " denoes defined as. The inflaion rae for period is he change beween end of period and end of period -1. This inflaion rae is expressed as a fracion. To express as a percenage muliply by 100. The ex denoes he percenage inflaion: P % P x100 P 1 1

8 I4-7 Proporional change in he price level from he previous period. An increase (decrease) in he price level is referred o as inflaion ( deflaion ). Hyperinflaion describes a very high rae of inflaion, usually 100% or more a year i.e. π 1. Inflaion (Con d) e.g. p322, Bolivia in 1985 Ukraine in 1983 π = 110 π = 50 (FYI: my paper, Currency Transacions Coss and Compeing Fia Currencies explains why domesic money coninues o be used in hyperinflaions.)

9 Inflaion (Con d) e.g. In German in 1923, he rae of inflaion hi percen per monh (prices doubled every wo days). Quesion: A his rae, wha is he annual (ne) inflaion rae? (In your calculaions, firs work ou he gross inflaion rae.) Deflaion corresponds o a negaive inflaion rae: π < 0. - In a deflaion, money increases in value! See Inflaion Propaganda Film (up o 9:25) I4-8

10 v v The Value of Money denoes he Value of Money = 1/ P : in unis of goods and services per dollar e.g. A doubling of he price level resuls in he value of money going down by half. Thus, money buys 50% less goods and services. Ex. Wha is he relaionship beween he rae of inflaion,, and he rae of reurn on money, π v v υ υ v 1, where? 1 I4-9

11 Inflaion-Targeing Policy The Bank of Canada (BOC) follows a inflaion-argeing policy, which aims a 2% inflaion and o keep (core) inflaion wihin bounds of 1% o 3% (see Ch. 20). Ex. Wha are he implicaions of his policy for he pah of prices and he value of money. Sar a = 0 wih P 0 = 1. (FYI: For my evaluaion of inflaion polices see When is Price-Level Targeing a Good Idea? ) I4-10

12 Consumer Price Index in Canada CPI Core CPI

13 Equaion of Exchange M V = P Y Quaniy of Money (M ) x Velociy of Money (V ) = Nominal GDP where Nominal GDP = Price level (P ) x Real Oupu (Y ) I4-12

14 Equaion of Exchange (Con d) M V = P Y implicily defines he Velociy of Money: V PY = M V is he average number of imes a year ha a dollar is spen. Cauion: Be careful o disinguish V, v and. υ I4-13

15 Equaion of Exchange (Con d) M V = P Y implies he approximaion ( ) used in Ch. 21: % M + % V % P + % Y (15) %Money Growh + %Velociy Growh %Inflaion + %Real Growh I gives close o he exac value for small changes. e.g Inflaion = 2%; Real Growh = 2.25%; Velociy Growh= 0.75%. Then (15) implies % M 2%+ 2.25%+0.75% = 5%. Quesion: Find he exac rae of money growh? I4-14

16 Daa: Money Growh and Inflaion I4-15

17 I4-16 Money Growh and Inflaion (con d)

18 I4-17

19 Quaniy Theory of Money The Quaniy Theory of Money combines he Equaion of Exchange M V = P Y wih Classical Dichoomy assumpions. I4-18 The basic Quaniy Theory of Money assumes velociy and oupu are consan and implies: V V P = M = M Y Y The price level is deermined solely by he quaniy of money! (Equaion describes AD.)

20 Quaniy Theory of Money (Con d) In urn, his implies V P = M Y The price level changes solely from changes in he quaniy of money. This implies M M 1 π = m M 1 The inflaion is given by he rae of money growh, m! Ex. Show he seps in deriving π = m. I4-19

21 Quaniy Theory of Money (Con d) The basic Quaniy of Theory of Money predics ha inflaion increases a he same rae as money growh rae. - On a plo he daa would lie on he 45% line. - Helps o explain why high inflaion and money growh go ogeher. - I does no explain why low and moderae inflaion counries fall below he 45% line and hyperinflaion counries lie above he line. I4-20

22 I4-21 Quaniy Theory of Money (con d) Inflaion and Money Growh

23 I4-22 Quaniy Theory of Money (Con d) Classical Dichoomy : Only real forces deermine real variables, and only he money supply deermines he price level. Behavioral assumpions. In he long run: a) Aggregae oupu is a he full-employmen (equilibrium) level; b) Velociy is only deermined by he rae of echnological progress. Thus V and Y are independen of money supply M. Money is said o be neural i.e. money neuraliy. In he basic quaniy heory, which is wihou economic growh or echnological progress, velociy and oupu are assumed consan V = V and Y = Y.

24 Quaniy Theory of Money (Con d) I4-23 One of he oldes and mos successful economic heories. Firs described by David Hume (1752), he famous philosopher, in his paper On Money Formulaed by Irving Fisher, Milon Friedman and Rober Lucas, America s greaes economiss. Appropriaely modified, i can explain why: Low inflaion counries have inflaion raes below he 45% line because of posiive oupu growh. High inflaion counries lie above he 45% line velociy increases as people urn over heir money faser o avoid losing purchasing power.

25 Quaniy Theory of Money Demand (con d) The Quaniy Theory yields a ransacion demand for money, ha does no depend on he ineres rae. For example, wih velociy consan, money D demand, M, increases proporionaely wih nominal income: M D = 1 ( PY ) V Wih his heory, Moneariss (e.g. Milon Friedman) recommend argeing money growh, seing arges S for in order o conrol inflaion (see Ch. 21). M I4-24 S Ex. How would you se M o implemen an inflaionarge pah of 2% inflaion?

26 Quaniy Theory of Money Demand (con d) I4-25 Canada was he firs counry o adop Milon Friedman s policy of argeing money growh. The policy sared in 1975 bu was considered a failure and abandoned in Velociy became unseady when he BOC ried o arge he money supply. Currenly, he BOC arges inflaion by using an ineres rae, he overnigh rae, raher han money supply o conrol he money marke and inflaion. I is widely believed ha ineres raes affec money demand so ha he Classical Dichoomy doesn hold, a leas in he shor run. Quesion: In he Inflaion Propaganda Film is money neural?

27 I4-26 Quaniy Theory of Money Demand (Con d) Is he Velociy Consan?