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Chapter-5: Inflation: Its Causes, Effects, and Social Costs
Chapter-5: Inflation: Its Causes, Effects, and Social Costs
COURSE TEACHER:
D R . TA M G I D A H M E D C H O W D H U R Y
A S S O C I AT E P R O F E S S O R , S B E
OBJECTIVES OF THE CHAPTER
M V P Y
How the price level is determined:
With V constant, the money supply determines nominal GDP (P Y ).
Real GDP is determined by the economy’s supplies of K and L and the production function
(Chap 3).
QUANTITY THEORY AND ITS RELATION TO
INFLATION
MxV=PxY
In order to calculate the change in each variable, the equation can be modified to:
M V P Y
M V P Y
100
Turkey
Ecuador Indonesia
Inflation rate Belarus
(percent,
logarithmic scale)
10
Argentina
1 U.S.
Switzerland
Singapore
0.1
1 10 100
Money Supply Grow th
(percent, logarithmic scale)
SEIGNIORAGE
To spend more without raising taxes or selling bonds, the govt can print
money.
The “revenue” raised from printing money
is called seigniorage
(pronounced SEEN-your-idge).
The inflation tax:
Printing money to raise revenue causes inflation. Inflation is like a tax
on people who hold money.
EFFECT OF INFLATION IN MONEY MARKET:
INFLATION & INTEREST RATE
Nominal interest rate, i not adjusted for inflation Inflation and Nominal Interest Rate in BD
20
18
Real interest rate, r adjusted for inflation: 16
r = i 14
7.1
12
(M P ) L (i , Y )
d
• When people are deciding whether to hold money or bonds, they don’t know what inflation
will turn out to be.
EX: Fed announces it will increase M next year. People will expect next year’s P to be
higher, so e rises.