Money Growth and Inflation

• Money growth and inflation are governed by a bank's monetary control tools.

Open Market Operations

• Outright open market operations involve the sale or purchase of non-monetary assets to or from the banking sector by a central bank.
• There is no agreement to reverse the transaction at a later date.

The Refinancing Rate

• Repurchase agreements involve the sale of a non-monetary asset together with an agreement to repurchase it at a set price at a specified future date.
• The repo rate is the interest rate at which the Bank of England lends on a short-term basis to the UK banking sector.
• The money market is where commercial banks lend money to one another on a short-term basis.
• The refinancing rate is the interest rate at which the European Central Bank lends on a short-term basis to the euro area banking sector.

Money Growth and Inflation Examples

• Significant rises in price levels have occurred in former Yugoslavia and Zimbabwe.
• Zimbabwean authorities announced that the CPI reached 231,000,000 percent in June 2008.
• Zimbabwe's central bank reported some goods on the black market increased by 70,000,000 percent.
• Unskilled workers in Zimbabwe earned around Z$200,000,000,000 a month, equivalent to about US$10 (€9.20, £6.80).
• In July 2008, the Government of Zimbabwe issued a Z$100 billion note.

How Supply and Demand Determine Equilibrium Price Level

• The supply curve for money is vertical since the central bank fixes the quantity of money supplied.
• The demand curve for money slopes downward because people prefer to hold more money when it buys less.
• The value of money and the price level adjust to balance the quantity of money supplied and demanded.

The Effects of a Monetary Injection

• The quantity theory of money states that the quantity of money determines the price level.
• The growth rate in the quantity of money determines the inflation rate.
• Nominal variables are measured in monetary units.
• Real variables are measured in physical units.
• Classical dichotomy involves the theoretical separation of nominal and real variables.

Monetary Injection Effects on Money Supply

• Monetary injection shifts the supply curve to the right.
• Equilibrium moves from point A to point B, decreasing the value of money and increasing the price level.

Relative Prices

• Prices are quoted in terms of money as nominal variables.
• The price of wheat is €2 a kilo, and the price of barley is €1 a kilo.
• Relative price is the amount of one good that must be given up to purchase another.

Real Wages

• Real wages are the inflation-adjusted money wage and are measured by the ratio of the wage rate to price (W/P).

Velocity of Money

• Velocity of money is the rate at which money changes hands.
• Velocity is the nominal value of output (nominal GDP) divided by the quantity of money.
• V = (P x Y) / M, where P is the price level (GDP deflator), Y is the quantity of output (real GDP), and M is the quantity of money.
• Equation: M x V = P x Y, relates the quantity of money (M) to the nominal value of output.

The Inflation Tax

• Governments can pay for spending by printing more money.
• Inflation tax is the revenue governments raise by creating money.
• Hyperinflation is a period of extreme and accelerating increases in the price level, exceeding a monthly rate of 50%.

The Fisher Effect

• A change in money growth does not affect the real interest rate.
• The nominal interest rate must adjust to changes in the inflation rate.
• Central bank increase in money growth results in a higher inflation rate and a higher nominal interest rate.
• This adjustment of the nominal interest rate to the inflation rate is the Fisher effect.

Costs of Inflation

• Inflation can lead to a fall in purchasing power, shoe leather costs, and menu costs.