ECON1102 Lecture Notes - Lecture 5: Money Market Account, Bank Reserves, Fiat Money
TOPIC 5A MONEY AND INFLATION
AUSTRALIAN INFLATION
- Since the 1960s, the Australian (and US) inflation rate has been positive. Inflation has also become
more persistent: a high inflation rate this year is more likely to be followed by a high inflation rate next
year.
- RBA keeps inflation 2-3%. Cannot perfectly control inflation.
- If it ould target .5% ould sa the hae a degree of otrol that the dot hae.
- Can have temporary shocks that force the inflation rate out of the range.
GREAT INFLATION OF THE 1970S
- During the Great Inflation, the rate peaked below 15 percent yet the inflation tax was a small fraction
of government spending.
- Inflation rose in the 1970s for the following reasons:
o OPEC coordinated increases in oil prices that spurred inflation.
o In many countries their central banks made mistakes in running a monetary policy that grew the
money supply too rapidly.
o Policymakers pursued such a policy because of the productivity slowdown
MONEY
- Money emerged to overcome the inefficiencies of a barter economy
- Paper currency
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- Is a record keeping device. Money is memory.
- Historiall aked gold or siler ut toda urre is fiat oe – paper that the govt. simple
declares is worth a certain price
- Money takes on value because we expect others will value it
- Double coincidence of once. Need bilateral understanding.
- Money as memory
MEASURING MONEY
- Different countries measure money in slightly different ways.
- In the US:
o The monetary base includes currency and accounts, called reserves, which private banks hold with
the eoos etral bank, which pay no interest.
o Reserves ensure that banks have sufficient cash on hand in case there is a run on the bank asking
for currency withdrawals.
o M1 adds demand deposits to the money base.
o M2 adds savings accounts and money market account balances to M1.
- Cash is the most liquidated form of money
- Monetary banks = reserves + money.
- Can go to M4
- The Reserve Bank of Australia defines the monetary aggregates as:
o M1: currency bank + current deposits of the private non-bank sector
o M3: M1 + all other bank deposits of the private non bank sector
o Broad Money: M3 + borrowings from the private sector by NBFIs, less the latter's holdings of
currency and bank deposits.
o Money Base: holdings of notes and coins by the private sector plus deposits of banks with the
Reserve Bank of Australia (RBA) and other RBA liabilities to the private non-bank sector. Coins and
notes and central bank reserves. Central bank controls the money supply by controlling notes and
coins and reserves, only money base under control of central bank. Only 10% of money.
- Money is generated by banks lending money. E.g. hold 10% and lend the remaining 90%. The public
takes that money and then deposits again in the bank. You get a money multiplier process → money
supply increases through repeated lending of title funding. Suggest there is a fixed multiplier. Central
bank can control supply e.g. by increasing money supply through injecting in banks. Banks lend when a
customer comes and they are wroth lending to.
- Money debt care → when a bank extends a loan. After a loan is paid back money is destroyed. This
shows why their can be a temporary discount with the finance world and central bank policy meetings.
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o As we add additional elements to the broader measures of the money, the accounts become less
liquid
o As asset is less liquid if it is harder to turn into currency in a short period.
AUSTRALIAN MONEY SUPPLY
- Austs. Money supply has
increased.
- Orange is under direct control of
the central bank
- Lot more debt. (Grey area). Debt
is not forever expandable.
QUANTITY EQUATION OF MONEY
- The quantity theory of money allows us to make the connection between money and inflation
- We assume the real variables. Nominal side is the bit that refers to money and prices (arbitrary labels).
Brings nominal and real side
- Let Mt = the money supply; let Pt = price level; let Yt = real GDP:
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Document Summary
Since the 1960s, the australian (and us) inflation rate has been positive. Inflation has also become more persistent: a high inflation rate this year is more likely to be followed by a high inflation rate next year. If it (cid:272)ould target (cid:1006). 5% (cid:449)ould sa(cid:455) the(cid:455) ha(cid:448)e a degree of (cid:272)o(cid:374)trol that the(cid:455) do(cid:374)(cid:859)t ha(cid:448)e. Can have temporary shocks that force the inflation rate out of the range. During the great inflation, the rate peaked below 15 percent yet the inflation tax was a small fraction of government spending. Inflation rose in the 1970s for the following reasons: opec coordinated increases in oil prices that spurred inflation. In many countries their central banks made mistakes in running a monetary policy that grew the money supply too rapidly. Policymakers pursued such a policy because of the productivity slowdown. Money emerged to overcome the inefficiencies of a barter economy.
