Transcript Nominal & Real

Practice Test #1
I do NOT
set money supply
or interest rates!
I do NOT
control taxes
or spending
Fiscal Policy vs. Monetary Policy
Money Unit Wrap Up
Monetary Policy Wrap-Up
Monetary vs. Fiscal Policy
• Monetary Policy does not put money directly into the economy
– Fiscal Policy does! (Taxes & Gov’t Spending)
• Instead it depends on cause/effect relationships:
– ∆ in money supply => ∆ interest rates => ∆ in consumption/ investment
• The Fed does not control the amount of money that:
– households choose to hold as deposits
– bankers choose to lend, individuals choose to borrow
Credit Crunch
This is why the Fed
feared deflation in 2008-11!
Monetarism Summary
• Main message: Money is neutral & the economy self-regulates
– Use Quantity Theory of Money MV = PY (where V is constant)
– Inflation is purely a monetary phenomena
• Monetarists do not support activist monetary policy stabilization:
– i.e. expanding money supply during bad times and slowing during good
– They focus primarily on price stability
• Theory not compatible with upward sloping AS curve or
Keynesian economics
Classical Dichotomy
• A Pre-Keynesian theory that separates nominal from real variables
to analyze an economy
– Nominal variables measured in monetary units
– Real variables measured in physical units
• Classical economists look at real variables---ignore nominal
– Assume monetary neutrality for classical dichotomy
– Keynesian economists reject this theory
Review:
Nominal Interest Rate = Real Interest Rate + Expected Inflation
Real Interest Rate
= Nominal Interest Rate – Expected Inflation
Practice Free Response
Austrian Economics
• Friedrich Hayek (1899 – 1992)
– Austrian School of Economics
• Against active Fed Policy
• Promoted “self regulation” of free market
• Believed low interest rates led to Malinvestment
Round 2
Round 2 http://www.youtube.com/watch?v=GTQnarzmTOc
Round 1 http://www.youtube.com/watch?v=d0nERTFo-Sk
The Inflation Tax
• When the federal reserve prints money it is said to levy an
inflation tax
– a tax on everyone who holds money or saves money
• Interest earned on savings is 100% taxed even though part of it
merely compensates for inflation