Lecture Eight
Money and Inflation
(Economics 100b; Spring 1996)
Professor of Economics J. Bradford DeLong
601 Evans, University of California at Berkeley
Berkeley, CA 94720
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net
February 5, 1996
Feedback
What Is "Money"?
The "Quantity" of "Money"
Nominal Spending as Determined by the Quantity of Money
Feedback
Feedback, necessity of, in such a large course...
Still a few bugs in the system: apology for handout error...
What Is "Money"?
You have already encountered the phenomenon that economists use
familiar words in unfamiliar, technical ways: if I buy a share of
Apple Computer from you, and you take the money and use it to buy
xerox paper, then that is not an "investment" as economists use the
word. But if I buy a newly-issued share of, say, Visioneer
Corporation, and if the money then flows into Visioneer's corporate
accounts and is used not to build a factory but to add to the pile of
scannersin Visioneer's warehouse, that is
investment--investment in inventories.
Economists use the word "money" in a similar, technical, not very
intuitive way. To an economist, "money" is wealth in the form of
ready purchasing power. To the world at large, "money" is much
closer to being a synonym for "wealth" or "income". Beware of this
definitional, technical phenomenon. If you forget it, you may well
get tripped up.
Almost every economics textbook refers to three functions of money:
- as a store of value
- as a unit of account
- as a medium of exchange
Store of value. You want to put your wealth in the form of
"money" because you are pretty certain that "money" will not decline
in value between now and next week (or next year).
Unit of account. You (and everyone else) quotes prices and
reckons debts and contracts in "money" for convenience and
transparency. Double coincidence of wants
Medium of exchange. You (and everyone else) are willing to accept
"money" as payment when you sell something. Legal tender.
Digression on gold clauses?
Commodity money/ gold/ gold standard/ fiat money. Why use fiat
money? A lot cheaper to produce. The people who would otherwise be
producing commodity money can be employed doing something more
useful...
Why use commodity money? Fear of inflation/default. Change in
yardstick...
Natural resolution? Use fiat money as a means of payment, but
commodity money as a unit of account/store of value. However,
we almost never see this arrangement, especially not today...
Digression on indexed bonds. Tesebonos...
The coincidence of the medium of exchange function with the
unit of account function can lead to trouble, in the form of
inflation, as we will see...
The "Quantity" of "Money"
The "quantity" of "money" is a medium-of-exchange function. (Amounts
as of December 1994)
High-powered money:
- Federal Reserve notes and coin ($354 billion)
- Deposits held by commercial banks at the Federal Reserve. ($59
billion)
Demand deposits:
- Deposits that people can spend by writing checks... ($785
billion)
- (Includes traveler's checks) ($8 billion)
High-powered money plus demand deposits = "M1" ($1,147 billion
(note double counting))
"Amphibians"
- Overnight repurchase agreements and eurodollars ($117 billion)
- Money-market deposit accounts and other savings deposits ($891
billion)
- Money-market mutual fund shares ($320 billion)
- Small "time deposits" ($818 billion)
M1 plus amphibians = "M2" ($3,293 billion)
To get to "M3" ($3,451 billion) add:
- Large time deposits ($104 billion)
- Term repurchase agreements ($54 billion)
To get to "L" ($4,409 billion), add:
- Savings bonds ($181 billion)
- Short-term Treasury securities ($358 billion)
- "Other liquid assets" ($419 billion)
And I'm sorry, I have forgotten what "other liquid assets" means.
Bankers' acceptances; commercial paper; and something else..
You will see that none of these have much relevance for "unit of
account"; but all have relevance for "medium of exchange"
Nominal Spending as Determined by the Quantity of Money
Why pay attention to this forest of "Ms"? Because there is a very
real sense in which all of these assets are held to spend. No
one keeps money in their checking account--or no one should keep
money in their checking account--if they are not going to spend it.
At the moment my wife and I have a--rather large--sum in our
checking account because this spring we are planning to buy a car and
a house.
And so when people pile up their wealth into the form of these "Ms",
they do so because they are planning to spend it. And spend it they
do, at a more-or-less constant rate.
The quantity equation:
M V = P Y
V is the income velocity of money. Different Vs for
each M concept...
Quantity equation an identity. Quantity "theory" is the
quantity equation plus the prediction that velocity V is not
going to change much.
Implication is that if you know M, and if you can forecast V, then
you know nominal GDP--you know P times Y.
Is velocity that stable? Well, look and see...
Goodhart's law
Alan Blinder and Janet's attempt to get the FOMC to take their
monetary targets seriously...
The Volcker deflation; Henry Wallich and Charles Schultze on the
benefits and dangers of switching from targetting i's to targetting
M's.
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