The document discusses the classic theory of inflation and the costs of inflation. It explains that according to the quantity theory of money, the overall price level is determined by the supply of money - when the money supply increases, it causes inflation. Six main costs of inflation are identified: shoeleather costs, menu costs, increased variability of relative prices, unintended tax liability changes, confusion and inconvenience, and arbitrary redistributions of wealth. Unexpected inflation in particular can redistribute wealth in ways unrelated to merit or need.

1. 1
Principles of Economics
Chapter30
Monetary
Growth and
Inflation

2. 2
Relative Chapter
• PattⅧ The data of macroeconomics
– 24 Measuring the cost of living
• PartⅨ The real economy in the long run
– 26 Saving,Investment,and the financial sytem
• PartⅩ Money and prices in the long run
– 29 The monetary system
– 30 Money growth and inflation

3. 3
What is inflation?

4. 4
Much Money?

5. 5
Grapha?

6. 6

7. 7
Today's Theme
• What determines whether an economy experiences
inflation and ,if so, how much?
• Why is inflation a problem?
• What are the costs of that inflationimposes on a
socety?

8. 8
What is inflation?

9. 9
Index
• The classic theory of inflation
• The costs of inflation

10. 10
Index
• The classic thory of inflation
• The costs of inflation

11. 11
The classic theory of Inflation
• Supply
– simply the quantity of money supplied as a policy
variables that Fed controls.
• Demand
– how much wealth people want to hold in liquid form.
– the average levels of prices
(a higher price level increases the quantity of money
demand)
Supply and Demand detemines the value of money

12. 12
Figure 1 Money Supply, Money Demand,
and the Equilibrium Price Level
Quantity of
Money
Value of
Money, 1/P
Price
Level,P
Quantity fixed
by the Fed
Money supply
0
1
(Low)
(High)
(High)
(Low)
1
/2
1
/4
3
/4
1
1.33
2
4
Equilibrium
value of
money
Equilibrium
price level
Money
demand
A
In the long run, the overall level of prices adjusts to the level at which
the demand for money equals the supply.

13. 13
Figure 1 Money Supply, Money Demand,
and the Equilibrium Price Level
Quantity of
Money
Value of
Money, 1/P
Price
Level,P
Quantity fixed
by the Fed
Money supply
0
1
(Low)
(High)
(High)
(Low)
1
/2
1
/4
3
/4
1
1.33
2
4
Equilibrium
value of
money
Equilibrium
price level
Money
demand
A
In the long run, the overall level of prices adjusts to the level at which
the demand for money equals the supply.

14. 14
The quantity theory of money
• Quantity theory of money
– a theory asseting that the quantity of money available
determines the price level and that the growth rate in
the quantity of money available determines the inflation
rate.
• "Inflation is always and everywhere a monetary
phoenomenon"

15. 15
Figure 2 The Effects of Monetary Injection
Quantity of
Money
Value of
Money, 1/P
Price
Level, P
Money
demand
0
1
(Low)
(High)
(High)
(Low)
1
/2
1
/4
3
/4
1
1.33
2
4
M1
MS1
M2
MS2
2. . . . decreases
the value of
money . . .
3. . . . and
increases
the price
level.
1. An increase
in the money
supply . . .
A
B

16. 16
Caution!
regarding money supply
• When the Fed buys government bonds,it pays out dollars
and expands the money supply.
• If any of these dollars are deposited inbanks which hold
some as reserves and loan out the rest,the money multiplier
swings into action.
• In this chapter, we ignore the complications introduced by
the banking system.

17. 17
Transmission mechanism of monetary policy
オペレーション
中央銀行当座預金
オーバーナイト金利
貸出供給
資産価格
為替レート
担保価格
総支出
予想物価上昇率
中長期金利
実質長中長期金利
相対資産価格
金利チャネル
信用チャネル
為替チャネル
マネタリストチャネル
量的緩和チャネル

18. 18
A brief look at the adjustment
process
• The economy's output of goods and services is
determined by the available labor,physical capital,human
capital,natural resources and technological knowledge.
• The injection of money alter none of these.

19. 19
The classis dichotomy and
monetary neutrality
• Classical dichotomy
– the theoretical separation of nominal and real
variables
• Monetary neutrality
– the proposition that changes in the money
supply do not affect real variables.

20. 20
Velocity and the quantity eqation
YPM ×=×V
V= velocity
P= the price level
Y= the quantity of output
M= the quantity of money

21. 21
Figure 3 Nominal GDP, the Quantity of Money, and
the Velocity of Money
Indexes
(1960 = 100)
2,000
1,000
500
0
1,500
Nominal GDP
Velocity
M2
The velocity of money has not changed dramatically.

22. 22
the Equilibrium Price Level, Inflation Rate, and
the Quantity Theory of Money
1. The velocity of money is relatively stable over time.
2. When the Fed changes the quantity of money, it causes proportionate
changes in the nominal value of output (P × Y).
3. Money is neutral, money does not affect output.
4. With Y determined by factor supplied and technology,when the central
bank alters M and induces proportional changes in the nominal value of
output(P×Y),these are reflected in changes in P
5. When the central bank increase the money supply rapidly,the result is a
high rate of inflation.

23. 23
the inflation tax
• Inflation tax
– the government raises revenue by printing money
• The massive increases in the quantity of money
lead to massive inflation.
• The inflation ends when the government institutes
fiscal reforms that eliminate the need for the
inflation tax.

24. 24
Fisher effect
• Fisher effect
– the one-for-one adjustment of the nominal interest rate
to the inflation rate.
• The Fisher effect has maintained a long-run
perspective and need not hold in the short run
because inflation may be unanticipated.
Nominal interest rate
=Real interest rate + Inflation rate

25. 25
Figure 5
The Nominal Interest Rate and the Inflation Rate
Percent
(per year)
1960 1965 1970 1975 1980 1985 1990 1995 2000
0
3
6
9
12
15
Inflation
Nominal interest rate

26. 26
Index
• The classic thory of inflation
• The costs of inflation

27. 27
Economists have identified
six costs of inflation
• Shoeleather costs
• Menu costs
• Increased variability of relative prices
• Unintended tax liability changes
• Confusion and inconvenience
• Arbitrary redistributions of wealth

28. 28
The costs of inflation
• Shoeleather Costs
– the resources wasted when inflation encourages people
to reduce their money holdings
• Menu Cost
– the cost of changing prices
• Relative-price variability and the misallocation of
resources
– When inflation distorts relative prices,consumer decisions
are distorted, and markets are less able to allocate
resources to their best use.

29. 29
Inflation-induced tax distortions
EconomyA
(Price stability)
EconomyB
(Inflation)
Real interest rate
4%
4%
Inflation rate
0
8%
Nominal interest rate
(real interest rate+ inflation rate)
4
12
Reduced interest due to 25% tax
(0.25 ×nominal interest rate)
1
3
After-tax nominal interest rate
(0.75 ×nominal interest rate)
3
9
After-tax real interest rate
(after-tax nominal interest rate-inflation rate)
3
1
More complete indexation would be desirable,but it would further complicate
a tax code that many people already consider too complex.

30. 30
Confusion and Inconvenience
• When the Fed increases the money supply and
creates inflation, it erodes the real value of the
unit of account.
• Inflation causes dollars at different times to have
different real values.
• Therefore, with rising prices, it is more difficult to
compare real revenues, costs, and profits over
time.

31. 31
A special cost of unexpected inflation
Arbitrary redsistributions of wealth
• Unexpected inflation redistributes wealth among the
population in a way that has nothing to do with either merit
or need.
• There are no known examples of economies with high,stable
inflation.
• If a country pursue a high-inflation monetary policy
– the costs of high expected inflation
– the arbitary redistributions of wealth associated with unexpected
inflation

32. 32
Deflation may be worse
• Friedman rule
– Some economists have suggested that a small and
predictable amount of deflation may be desirable.
• The costs of deflation
– Some of these mirror the costs of inflation
– Delfation often arises because of broader macro
economic difficulties.