Money and Prices in the Long Run
1. The Monetary System
1.1 Money
Money: the set of assets in an economy that people regularly use to buy goods and services from other people
The Functions of Money:
- medium of exchange
- unit of account
- store of value: transfer purchasing power from the present to the future
- liquidity: the ease with which an asset can be converted into the economy’s medium of exchange
The Kinds of Money:
- commodity money: money that takes the form of a commodity with intrinsic value (e.g. gold)
- fiat money: money without intrinsic value that is used as money by government decree (official order)
Money in the economy:
- currency: the paper bills and coins in the hands of the public
- demand deposits (活期储蓄): balances in bank accounts that depositors can access on demand by writing a check
M1 & M2:
Traveler's checks (旅行支票)
savings deposits (储蓄存款)
Credit Cards Aren’t Money
1.2 The Federal Reserve System
The Fed has two related jobs:
- regulate banks and ensure the health of the banking system
- lender of last resort—a lender to those who cannot borrow anywhere else—to maintain stability in the overall banking system
- monetary policy: control the quantity of money that is made available in the economy
- Federal Open Market Committee (FOMC)
- Fed’s primary tool: open-market operation: the purchase and sale of U.S. government bonds
1.3 Banks and the Money Supply
reserves: deposits that banks have received but have not loaned out
reserve ratio \(R\) : the fraction of deposits that banks hold as reserves
money multiplier: the amount of money the banking system generates with each dollar of reserves
$$
\text{money multiplier} = {1 \over R}
$$
leverage (杠杆): the use of borrowed money to supplement existing funds for purposes of investment
leverage ratio: the ratio of assets to bank capital $$ \text{leverage ratio} = {\text{assets} \over \text{capital}} $$ capital requirement: a government regulation specifying a minimum amount of bank capital
1.4 The Fed’s Tools of Monetary Control
How the Fed Influences the Quantity of Reserves:
- Open-Market Operations
- Fed Lending to Banks
- discount rate (贴现率): the interest rate on the loans that the Fed makes to banks
- The Fed can alter the money supply by changing the discount rate.
How the Fed Influences the Reserve Ratio:
- reserve requirements
- Paying Interest on Reserves: when a bank holds reserves on deposit at the Fed, the Fed now pays the bank interest on those deposits
The Federal Funds Rate:
- the short-term interest rate that banks charge one another for loans (the loans are temporary—typically overnight)
- the Federal Reserve has set a target goal for the federal funds rate
- open-market purchases lower the federal funds rate, and open-market sales raise the federal funds rate
- Decisions by the FOMC to change the target for the federal funds rate are also decisions to change the money supply. They are two sides of the same coin.
2. Money Growth and Inflation
2.1 The Classical Theory of Inflation
explain the longrun determinants of the price level and the inflation rate
2.1.1 Classical Dichotomy
classical dichotomy: the separation of real and nominal variables
monetary neutrality: the proposition that changes in the money supply do not affect real variables
2.1.2 Quantity Equation
velocity of money: the rate at which money changes hands $$ V = {\text{nominal value of output} \over \text{quantity of money}} = {\text{nominal GDP} \over M} = {P \times Y \over M} $$
where \(P\) is the price level (the GDP deflator) and \(Y\) is the real GDP
quantity equation: relates the quantity of money, the velocity of money, and the dollar value of the economy’s output of goods and services
increase rate of the quantity of money = increase rate of price level (inflation) + increase rate of quantity of output (real GDP)
inflation tax: the revenue the government raises by creating money
2.1.3 The Fisher Effect
Fisher effect: the one-for-one adjustment of the nominal interest rate to the inflation rate $$ \begin{aligned} \text{Real interest rate} &= \text{Nominal interest rate} - \text{Inflation rate} \ \Rightarrow \text{Nominal interest rate} &= \text{Real interest rate} + \text{Inflation rate} \end{aligned} $$
2.2 The Costs of Inflation
inflation does not in itself reduce people’s real purchasing power
- Shoeleather Costs: the resources wasted when inflation encourages people to reduce their money holdings
- Menu Costs: the costs of changing prices
- Relative-Price Variability and the Misallocation of Resources
- Inflation-Induced Tax Distortions
- Confusion and Inconvenience
- A Special Cost of Unexpected Inflation: Arbitrary Redistributions of Wealth