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Lecture 4

ECON 2000 Lecture Notes - Lecture 4: Limited Government, Fisher Hypothesis, Quantitative Easing


Department
Economics
Course Code
ECON 2000
Professor
Perry Sadorsky
Lecture
4

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Chapter 4 – Money and Inflation
Introduction
Hyperinflation – rate exceeding 50% per month
Occur when money supply grows too rapidly
What is Money?
Real variable – variable measured in terms of goods and services
Nominal variable – variable measured in terms of money
Classical dichotomy – the assertion that in the long run, nominal variables, such as price
level or money supply do not affect real variables, such as real GDP or the level of
employment
Money – any asset that is used to facilitate transactions
Money supply – the quantity of assets available to households and firms to conduct
transactions
Liquidity of an asset – the ease of using the asset as payment in a transaction
oMoney is the most liquid
Income is NOT the same as money
oIncome is a flow – dollars per unit of time
oMoney is a stock – dollars at a moment of time
Barter, Money and Transaction Costs
In the olden days – barter – direct exchange of one good or service for another
oNeeds to be a double coincidence of wants – two parties must need each other’s
goods or services
Transaction costs – the costs in time or other resources of making a trade or an exchange
oBarter – costs were too high – inefficient economy
Commodity Money
A good used as money has value of independent of its use as money
Ex: cigarettes – can be used a money + can be smoked
With the introduction of money – producers could specialize + transaction costs were
reduced + raised production and incomes
In order for a good to be useful in an exchange:
oAcceptable to most people
oValuable relative to its weight
oStandardized in terms of quality – any two units are identical
oDivisible
oDurable – good not lost due to wear and tear
Ex: gold and silver
oAdvantages: valuable, need small amounts for transactions, easily evaluate purity
oDisadvantages: rub off, supply fluctuates, heavy
oGold and silver certificates – claim on a specific amount of metal
oBecame paper currency – fully backed
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oBanks realized that not everyone redeemed their certificates – issued more and
then became partially backed
Seigniorage
Bank of Canada has the sole right to print money
Seigniorage – the profit from issuing money
Difference between interest earned and the cost of printing the notes
Fiat Money
The profits that Bank of Canada makes goes to government as revenue
Since 1931 – Canadian dollar is fiat money – money, such as paper currency, that has no
value apart from its use as money
Intrinsically useless – can’t be used for other purposes
Accepted by everyone since you can use the money to buy other goods and services
Legal Tender
Means that notes are issued by Bank of Canada and coins made by Royal Canadian Mint
Functions of Money
Medium of exchange
oSomething that is generally accepted as payment for goods and services
Store of value
oThe accumulation of wealth by holding dollars or other assets that can be used to
buy goods and services
oMoney is not risky and is perfectly liquid
Unit of account
oA way of measuring value of an economy in terms of money – value goods and
services
Making The Connection
Money as a Store of Value in Cyprus
Cyprus was an off-shore banking center – for wealthy Russians
Assets exceeded 800% of GDP
Had a lot of Greek bonds
Needed a bailout – asked troika of European Union, International Monetary Fund and
European Central Bank – lent only 10 billion
Needed 14.8 billion
Due to fear of moral hazard, they asked Cyprus banks to gather 4.8 billion
Proposed that the bank deposits be taxed up to 15% - rejected by parliament
When Money if No Longer Money: Hyperinflation in Zimbabwe
Reserve Bank of Zimbabwe – not independent from the government – published too
much money
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