0 CHAPTER 4 Money and Inflation Chapter 4 Determination of Nominal Variables Classical Dichotomy Real Side: determined in the benchmark model in Chapter 3 Nominal Side: determined by the money supply “Classical” – assumes prices are flexible & markets clear Applies to the long run (a tricky concept)
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Chapter 4 Determination of Nominal Variableshome.gwu.edu/~cdwei/econ2102_chap04_f11_on.pdfCHAPTER 4 Money and Inflation 1 Nominal Variables The nominal variables of interest are: Money
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0 CHAPTER 4 Money and Inflation
Chapter 4 Determination of Nominal Variables
Classical Dichotomy Real Side: determined in the benchmark
model in Chapter 3 Nominal Side: determined by the money
supply
“Classical” – assumes prices are flexible & markets clear
Applies to the long run (a tricky concept)
1 CHAPTER 4 Money and Inflation
Nominal Variables
The nominal variables of interest are: Money Supply Prices Inflation
Once the above are determined, we can determine the following: Nominal GDP Nominal Interest Rate
U.S. inflation and nominal interest rates, 1960-2010
inflation rate
nominal interest rate
24 CHAPTER 4 Money and Inflation
Inflation and nominal interest rates across countries
1
10
100
1 10 100 1000
Nominal interest rate
(percent, logarithmic
scale)
Inflation rate (percent, logarithmic scale)
Zimbabwe Romania
Turkey Brazil
Israel
U.S.
Germany Ethiopia
Kenya
Georgia
25 CHAPTER 4 Money and Inflation
The Classical Dichotomy
Note: Real variables were explained in Chap 3, nominal ones in Chapter 4.
Classical dichotomy: the theoretical separation of real and nominal variables in the classical model, which implies nominal variables do not affect real variables.
Neutrality of money: Changes in the money supply do not affect real variables.
In the real world, money is approximately neutral in the long run.
26 CHAPTER 4 Money and Inflation
Chapter Summary
Money def: the stock of assets used for transactions functions: medium of exchange, store of value,
unit of account types: commodity money (has intrinsic value),
fiat money (no intrinsic value) money supply controlled by central bank
Quantity theory of money assumes velocity is stable, concludes that the money growth rate determines the inflation rate.