Tuesday 261013

 

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 10 Money and Prices in the Long Run

Chapter 29 of 36 Money Growth and Inflation

Section 11 of 29

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In Table A:

Y = production quantity, in this example how many pizzas are produced and consumed per time period, 100

P = price level, in this example the price of pizza, $10

M = money supply, quantity of money in the economy, in this example starts with $50

V = velocity of money, how many times in a year each dollar is spent (circulated), in this example starts with 20

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The quantity equation shows an increase in the M quantity of money from $50 to $60 must be reflected in one of the other three variables

Line 2 - the V velocity of money must fall

Line 3 - the P price level must rise

Line 4 - the Y quantity of output must rise

Note real GDP only increases when production quantity increases.

Line 3, price increase, is the real-life result.

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These are the essence of the quantity theory of money:

· the V velocity of money, is generally stable over time

· a change in M money supply causes a proportionate change in P price level, line 3

· the economy's V velocity and Y output of goods are not changed by change in money supply

· Y is changed by changes in factors, including: physical capital, human capital, natural resources, technology, political system including tax levels

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the quantity equation

sūryō hōteishiki

数量方程式

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Why doesn’t the Fed increase the money supply only according to production and sales quantity? ChatGPT:

Because the Fed has objectives besides simply matching money growth to production growth.

It also adjusts monetary policy to respond to recessions, unemployment, financial crises, credit shortages, and inflation that is already too high or too low.

In addition, real production cannot be measured perfectly in real time and future production is uncertain.

So even if the Fed wanted money supply growth to track production closely, it would still sometimes increase or decrease money growth for broader economic-stabilization reasons.

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Why is the Fed concerned about economy stabilization? Doesn't the economy naturally stabilize itself?

Yes, the economy has self-correcting forces, but the adjustment can be slow and painful.

After a recession, for example, falling wages and prices can eventually encourage hiring, investment, and spending, bringing the economy back toward full employment.

The Fed is concerned with stabilization because that process may take years and involve prolonged unemployment, business failures, falling incomes, or financial instability.

By adjusting interest rates and financial conditions, the Fed tries to reduce the severity and duration of these swings while maintaining price stability.

Economists disagree about how much intervention is desirable, because poorly timed or excessive Fed action can itself create instability.