Money, Inflation and The quantity theory of money Bzhar N. Majeed

Two types of inflation exist: 1- Normal/General inflation. 1- What is Inflation? Two types of inflation exist: 1- Normal/General inflation. 2- Hyperinflation. There is no unique definition of inflation. However, in can be said; it is increasing for overall prices through time. The difference between normal inflation and hyperinflation is hyperinflation is extraordinary rises of overall prices in the short time horizon. Bzhar N. Majeed

“Money can be anything that generally accepted by public” 2- What is Money? “Money can be anything that generally accepted by public” Having a lot of money does not make you reach. Money is a part of wealth. Price: is a required amount of money that is needed to make a transaction. Bzhar N. Majeed

A. The function of Money: 1- Store of value: money is a way to transfer purchasing power from the present to the future. 2- Unit of account: Money provides the terms in which prices are quoted and debts are recorded. 3- Medium of exchange: Money is what we use to buy goods and services. 4- Money as a means of deferred payment Bzhar N. Majeed

B. The type of Money: 1- Fiat money: the modern bank notes (money) at nowadays is a fiat money. It is called fiat money because it has not any intrinsic value and established as money by government decree. 2- Commodity money: opposite to fiat money it has intrinsic value. It has been used in most past societies for example gold money or the paper money that is redeemable for gold. Bzhar N. Majeed

C. The development of Fiat Money: At first; standardising the weight and purity of the gold in the shape of the coins. Second; government accepts gold from the public in exchange for gold certificate-pieces of paper that can be redeemed for a certain quantity of gold. Finally, because no one redeems the gold anymore and everyone accepts the paper, they will have value and serve as money. Bzhar N. Majeed

Open-Market Operations The purchase and sale of U.S. Treasury Bonds To expand the money supply: The Federal Reserve buys U.S. Treasury Bonds and pays for them with new money. To reduce the money supply: The Federal Reserve sells U.S. Treasury Bonds and receives the existing dollars and then destroys them. The bearer of the United States Treasury bond is hereby promised the repayment of the principle value plus the interest which it incurs through the terms stated thereof. The United States will justly repay its bearers in its entirety and will not default under any circumstances. Signature of the President ___________________ US. Treasury Bond

The quantity theory of money Having defined what money is and described how it is controlled, we can now examine how the quantity of money affects the economy. To do this, we must see how the quantity of money is related to other economic variables, such as prices and incomes. Bzhar N. Majeed

People hold money to: Buy goods Buy services The more money people need for such transactions, the more money they hold. Thus…. The quantity of money in the economy is related to the number of dollars (currency) exchanged in transaction. Bzhar N. Majeed

Money × Velocity = Price × goods & services M × V = P × Y The link between transactions and money is expressed in the following equation, called the quantity equation: Money × Velocity = Price × goods & services M × V = P × Y Y= is the amount of goods and services that trade in the economy P= the price of a typical transactions M= the quantity of money V= the transactions velocity of money. Velocity definition: the average number of time that money is exchanged from one transaction to another. Bzhar N. Majeed

Example, suppose that 60 loaves of bread are sold in a given year at $0.50 per loaf. Suppose that the quantity of money in the economy is $10. what is the velocity? M * V = P * T $10 * V = $0.50 * 60 V = $30 / $10 = 3 times per year. Bzhar N. Majeed

The quantity equation In order to analyse how money affects the economy, the terms of quantity of goods and services is expressed instead of quantity of money. Ex.: $10 = money supply. $0.50 = a price of a loaf. M/P = $10/$0.50 = 20 loaves of bread. The economic interpretation is; the stock of money in the market can buy 20 loaves in the current price. M/P = Real money balances. Bzhar N. Majeed