MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT 1/11/2019 MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT 2nd edition Money and Prices PowerPoint by Beth Ingram University of Iowa Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Key Concepts Inflation Monetarism Money Neutrality Quantity Theory Hyperinflation Inflation Tax and Seignorage Monetarism Money Neutrality Quantity Theory

Inflation The rate of change in the price level P(1) – P(0) Rate of Inflation = P(0)

UK Prices, 1661 - 1991

UK Inflation, 1661 - 1999

G7 Inflation, 1975 - 2000

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

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?

Costs of Inflation Nominal contracts Menu costs Relative price issues 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

What about deflation? Price uncertainty High real interest rates Real burden of debt

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)

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

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

Monetary Aggregates, June 2004 Source: Board of Governors On-line Statistics

Money Multiplier Vault Accumulation $10 $19 $26.10 … $100 $100 $90 $71 $190 $261 … $1000 Total Money Base Currency M1

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

Seignorage Profit made by a government by issuing currency, especially the difference between the face value of coins and their production costs 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

Seignorage Country % of GDP % Gov. 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

Seignorage Gresham's law is a monetary principle stating that "bad money drives out good." In currency valuation, Gresham's Law states that if a new coin ("bad money") is assigned the same face value as an older coin containing a higher amount of precious metal ("good money"), then the new coin will be used in circulation while the old coin will be hoarded and will disappear from circulation.

Declining value of Money 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

HyperInflation Hyperinflation is not a result from the dramatic increase in Money Supply  (although it certainly helps), but rather it is the loss of confidence in the currency

Seven Hyperinflations – 1920s and 1940s

The German hyperinflation 1922-23 (January 1922 =1)

Velocity: the circulation rate of money Quantity Theory MV = PY Velocity: the circulation rate of money Inflation is always and everywhere monetary phenomenon. Milton Friedman

%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 Money Supply Seignorage Inflation

US Inflation and Money Growth

UK Inflation and Money Growth

Cross-country Inflation and Money Growth, Long Run

Cross-country Inflation and Money Growth, Short Run

Summary Inflation Money Hyperinflation Measures Costs Deflation 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.