You are on page 1of 39

MACROECONOMICS

AND THE GLOBAL BUSINESS ENVIRONMENT

2nd edition

Money and Prices

1
PowerPoint by Beth Ingram
University of Iowa Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.
2

Key Concepts
 Inflation
 Inflation rate.
 Inlation rate on various prices- WPI, CPI.

 Causes of Inflation.
 Types of Inlation based on rates.
 Impact of Inflation.
 Control measures.
3

Inflation Rate
 The rate of change in the price level

P(1) – P(0)
Rate of Inflation =
P(0)
4

Measuring Inflation
 Consumer Price Index (CPI)
 Producers’ Price Index (PPI)
 GDP Deflator
 Ratio of Nominal GDP to Real GDP
 Mis-measurement issues
5

Calculation of Inflation Rate- India


 435 Commodities.
 Primary articles.
 Fuel, power, light and lubricant.
 Manufactured products.
6

Excluded
 Services.
 Real Estate.
7

Different weights
 Primary artcles – 22.02%.
 Fuel power light and lubricants – 14.2%.
 Manufactured products – 63.75%.
8

UK Prices, 1661 - 1991


9

UK Inflation, 1661 - 1999


10

G7 Inflation, 1975 - 2000


30 Canada

25 USA
France
20
Germany
15
Italy
10 Japan
5 UK
0
-5
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
11

Types of Inflation Based on Rates-


Samuelson
 Moderate – Creeping, walking.
 Running.
 Walking.
 Galloping.
 Hyper.
12

Moderate Inflation
a. creeping inflation ( less than 10 % per
annum).

B. walking inflation 10 % per annum)


13

Running Inflation

More than 10 % up to 20% per annum


14

Galloping Inflation

More than 20% up to triple digit per annum


15

Hyper

More than 1000% per annum .

Example – Germany. 1922. Zimbabwe- present.


16

Headline Inflation
 Weekly inflation data reported in newspapers.
17

Core Inflation
 Core inflation is a measure of inflation which
excludes certain items that face volatile price
movements e.g. food products and energy.
18

Money Neutrality
 Price level is a yardstick
 Does it matter which unit we use?
 Double all prices and incomes
 Is your welfare the same, better, or worse?
19

Costs of Inflation
 Nominal contracts
 Tax systems
 Mortgages
 Menu costs
 Transactions costs associated with changing
prices
 Effect of changes in pricing technology (bar
codes)
 Relative price issues
 Effect on long-run growth
20

What about deflation?


 Price uncertainty
 High real interest rates
 Real burden of debt
21

Money

Money was never a big motivation for me, except as a way to


keep score. The real excitement is playing the game.
Donald Trump, "Trump: Art of the Deal"

Money is a terrible master but an excellent servant.


Phineas Taylor Barnum

A billion here, a billion there - pretty soon it adds up to real


money.
Senator Everett Dirksen (1896 - 1969)
22

Why a currency?
 Role of money
 Store of value
 Medium of exchange
 Unit of account
 Kinds of money
 Commodity Money
 Backed currency
 Fiat Currency
23

The Money Supply


 M1: Currency + Traveler’s Checks + demand
deposits + other checkable deposits
 M2: M1 + retail money market mutual funds +
savings and small time deposits + overnight
repurchase agreements
 M3: M2 + large time deposits + term
repurchase agreements + eurodollars +
institutional money market mutual funds
24

Monetary Aggregates, June 2004

10000

8000

6000
M3
4000
M2

2000
M1
0
1

Source: Board of Governors On-line Statistics


25

Money Multiplier
Vault Accumulation
$10 $19 $26.10 … $100

$100 $90 $71 …

$100 $190 $261 … $1000

Total Money
Base Currency M1
26

Money Multiplier = 1/(reserve requirement)

 Assumes banks don’t hold excess reserves


 Assumes loans make it back to bank as
deposits
 Assumes currency doesn’t leave country
27

Seignorage
 How does it work?
 Direct – print money
 Indirect – print money, buy and hold
government debt
 Inflation Tax
 Decline in value of cash holdings due to
inflation
 Same as seignorage if inflation rate = growth
rate in currency
28

Seignorage

Country % of GDP % Country % of GDP % Gov.


Gov.Spending Spending
USA 0.43 1.96 Philippines 1.23 8.96

Canada 0.44 2.01 El Salvador 1.53 10.89

UK 0.47 1.28 Nigeria 1.57 11.12

France 0.55 1.39 India 1.72 11.82

Switzerland 0.62 6.74 Ecuador 2.17 15.81

Cameroon 0.64 3.38 Greece 3.13 10.51

S. Africa 0.65 2.53 Ghana 3.31 22.01

Germany 0.69 2.35 Turkey 3.58 15.20

Burundi 0.85 6.12 Bolivia 3.81 19.76

Japan 0.96 5.62 Peru 4.99 28.23

Thailand 1.09 6.30 Argentina 9.73 62.00


29

Hyperinflation
 High and persistent rate of inflation
 Relationship to fiscal policy

Finance government.
spending via inflation
tax

Rising Inflation
Declining value of Money

People decrease
money holdings by
buying goods
30

Seven Hyperinflations – 1920s and 1940s


End Avg. Avg
Price/Initial Monthly Monthly
Beginning End Price Inflation Money
Austria 01/10/21 01/08/22 70 47 31
Germany 01/08/22 01/11/23 1x10+10 322 314
Greece 01/11/43 01/11/44 4.7x10+6 365 220
Hungary I 01/03/23 01/02/24 44 46 33
Hungary II 01/08/45 01/07/46 3.8x10+27 19,800 12,200
Poland 01/01/23 01/01/24 699 82 72
Russia 01/12/21 01/01/24 1.2x10+5 57 49
31

The German hyperinflation 1922-23


(January 1922 =1)

Currency Prices Real Inflation


Money (% per month)

Jan 1922 1 1 1.00 5

Jan 1923 16 75 0.21 189

July 1923 354 2021 0.18 386

Sept 1923 227777 645946 0.35 2532

Oct 1923 20201256 191891890 0.11 29720


32
33

Quantity Theory

MV = PY
Velocity: the circulation rate of money

Inflation is always and everywhere monetary phenomenon.


Milton Friedman
34

%∆M + %∆V = %∆P + %∆Y


 Assume V = constant, so %∆V = 0
 %∆M = %∆P + %∆Y
 %∆Y determined by investment, technology,
etc.
 %∆M is proportional to %∆P

Growth in
Seignorage Money Inflation
Supply
35

US Inflation and Money Growth


10

8
1970s
1910s
6 1940s
1980s
Inflation %

4
1960s
1990s 1950s
2 1900s

0
1890s

1930s 1880s
-2 1920s 1870s

-4
0 2 4 6 8 10 12
Money Supply Grow th (%)
36

UK Inflation and Money Growth


37

Cross-country Inflation and Money


Growth, Long Run
38

Cross-country Inflation and Money


Growth, Short Run
39

Summary
 Inflation
 Measures
 Costs

 Deflation

 Money
 Definitions
 Multiplier
 Seignorage and Inflation Tax
 Hyperinflation
Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility
for errors, omissions, or damages caused by the use of these programs or from the use of the information contained therein.